Macro works: a decision-tree approach to exchange rate policy
Last Modified Date:
2021-06-09, 03:48 PM
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Since the Global Financial Crisis, international research and policy efforts have articulated a case for more interventionist management of capital inflows and exchange rates, motivated by the size and effects of gross flows of capital and a desire to maintain robust growth rates. This case differs considerably from the guidance during the Asian financial crisis period, which advised responding to capital inflows with higher saving achieved with more proactive fiscal, monetary and foreign exchange policies. Removing these macroeconomic policies from the toolkit leaves little other than macro- and microprudential instruments to address the over-leveraging, asset price inflation and relative price adjustments associated with sustained capital inflows. I show, through a decision-tree framework, theory and empirics, why the macroeconomic policy approach to capital flows should remain central to South Africa and how it can be strengthened further with asymmetric approaches to real exchange appreciation. Deep local currency capital markets and low inflation are key elements of reducing the real costs of currency volatility. These ideas can be generalised to other emerging economies with inflation targets and floating exchange rates.