Capital Flows in a Transitional Economy and the Sterilization Dilemma : The Hungarian Experience, 1992-97

Transitional economies adopted different exchange rates at the beginning of the transition to a market economy and Hungary, in particular, went through a number of changes in this area. In particular, Hungary can be said to have targeted the real exchange rate and, given recent interest in the experience of South American countries which have followed this policy, the experience of a transitional economy should also be of interest. The paper examines the success of Hungary's central bank at sterilizing capital inflows during the period 1992-97. The empirical evidence presented suggests that only during the second half of 1995 did the National Bank of Hungary begin to fully sterilize inflows of capital to neutralize their impact on domestic credit. More descriptive and anecdotal evidence further substantiates this finding. Prior to March 1995, conflicting monetary and fiscal policy objectives prevented the successful targeting of the real exchange rate