Navigating Capital Flows in Brazil and Chile

In the wake of the global financial crisis, many emerging market countries have been the recipients of unstable capital flows. Indeed, Brazilian President Dilma Rousseff has gone so far as to refer to post-crisis capital flows as a ‘tsunami’ that is a cause of great concern in the developing world. Different nations have responded to this challenge with different tools. Some nations have deployed capital account regulations, others have intervened in currency markets, and others have refrained from any activity at all. This paper analyzes the actions of Brazil and Chile between 2009 and the third quarter of 2011. During this period Brazil deployed capital account regulations and Chile intervened in its currency markets. We examine the effectiveness of each of these actions and the extent to which the actions of Brazil caused capital flow spillovers in the Chilean market. Consistent with the peer-reviewed literature on the subject, we find that capital account regulations had small but significant impacts on the shifting the composition of capital inflows toward longer-term investment, on the level and volatility of the exchange rate, on asset prices, and on the ability of Brazil to have independence in monetary policy. Brazil’s regulations did also temporarily cause an increase in capital flows into Chile. Chile’s interventions did not have a lasting impact on the Chilean exchange rate or on asset prices beyond the initial announcements of the policies. In Brazil’s case we thus conclude that Brazil’s regulations helped the nation ‘lean against the wind,’ but were not enough to tame the tsunami.