MercoPress. South Atlantic News Agency

High liquidity and capital flows impact on non crisis countries admits IMF

Inflow surges may lead to inflation and asset price bubbles

The unprecedented liquidity created by countries to fight the economic crisis could create problems for policymakers in some advanced and emerging market economies with relatively strong growth prospects and higher interest rates, the International Monetary Fund said in a new report.

The longer countries where the crisis originated maintain their low interest rate policies, the more likely it is that inflow surges will continue as investors will seek higher returns in stronger economies, it added.

In a special analysis that is part of its latest Global Financial Stability Report, the IMF discussed some of the after-effects of the global financial crisis-a surge in capital inflows arising from ramped up money supply and liquidity in the advanced economies meant to ease the effects of sharply curtailed credit.

The IMF also released two other analyses today. One looked at efforts to deal with institutions that are so large and interconnected that they pose systemic risks and the other examined how to deal with the systemic risks caused by the explosion in trading in over-the-counter derivatives.

The unconventional monetary policy measures undertaken during the crisis helped stabilize the financial system and supported the return to growth. However, the current highly liquid conditions and the resulting surge in capital flows pose policy challenges to a number of countries where the crisis did not originate.

The primary risk is rising inflation expectations in the domestic goods and assets markets, although, so far, asset valuations in economies experiencing capital inflows have not yet returned to pre-crisis levels. Sudden surges in capital inflows also raise concerns about vulnerabilities of those countries to abrupt stops or reversals in those flows once the global liquidity is unwound.

Although the benefits of capital inflows are manifold, sudden inflow surges may be lead to inflation and asset price bubbles. An analysis of the movement of abundant global liquidity and the accompanying surge in capital flows finds strong links with rising asset prices, such as equity returns, a decline in real interest rates, and official reserve accumulation in economies with comparatively higher interest rates and a stronger growth outlook, the IMF said.