When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options

In this paper we present evidence that capital account reversals have become more severe foremerging markets. Because policy options are limited in the midst of a capital market crisisand because so many countries have already had crises recently, we focus on some of thepolicies that could reduce the incidence of crises in the first place, or at least make the suddenstop problem less severe. In this regard, we consider the relative merits of capital controlsand dollarization. We conclude that, while the evidence suggests that capital controls appearto influence the composition of flows skewing flows away from short maturities, suchpolicies are not likely to be a long-run solution to the recurring problem of sudden capitalflow reversals. Yet, because fear of floating, many emerging markets are likely to turn toincreased reliance on controls. Dollarization would appear to have the edge as a more marketorientedoption to ameliorate, if not eliminate, the sudden stop problem.