central banks of non-euro EU countries (and to other countries as well if risks arise in EMCs in the extended European family of EU-aspiring countries) and second by broadening the range of eligible collateral for access to its financing facilities to securities denominated in other non-euro European countries should the need arise.

In the absence of these measures, countries would need to manage their systemic risks in other ways, mostly by putting in place more effective measures to prevent the kind of cycles of credit-boom and bust experienced in Europe during the most recent crisis but seen in many other countries during the past several decades, notably in Latin America and Asia. There is no shortage of country experiences and literatures that provide policy recommendations for preventing and dealing with the kind of balance-of-payments and capital-account crises that occurred in EU-NMSs.

# _3.2.c. Managing the risks associated with volatile capital flows_<sup>_47_</sup>

The epicenter of the global crisis of 2007–10 was the US financial system and economy and the principal locus of secondary eruptions was Western Europe. But the crisis became global, encompassing Central and Eastern Europe, Latin America, Asia, and Africa before running its course. A major transmission mechanism was the global financial system and associated capital flows, which dried up, first, for Iceland and Eastern Europe and ultimately for many of the major emerging-market economies, for example Korea. A second transmission mechanism was the recession in the advanced countries that led to a collapse in global trade that was unprecedented in the post-World War II era.<sup>48</sup> As is documented in Blanchard and Milesi-Ferretti (2009), the major portion of the precrisis gross capital flows involved the advanced countries, primarily of the North Atlantic. The emerging market economies were the source of net capital flows. CEE countries were the hardest hit emerging market countries, where net and gross capital flows, in large part from Western Europe and through foreign banks, financed large current account deficits and domestic asset booms – and later busts when the flows ebbed or reversed. However, the emerging market economies of Asia and Latin America, in particular, were also recipients of substantial gross capital flows.<sup>49</sup> In the aftermath of the global crisis, EU-NMS emerging-market countries as well as others have recovered more rapidly than the advanced countries. This has led some of their central banks to raise official interest rates, and so global capital flows have reemerged as a problem for some countries. A few have instituted controls to impede the inflow of capital.

> 47 This discussion follows Schinasi and Truman (2010) and draws on recent IMF work referenced below.

> 48 See IMF (2010b), Herman and Mihaljek (2010), and McGuire and von Peter (2009).

> 49 Korea is the most dramatic example. Korea had the fifth largest foreign exchange reserves as of February 2008 and ran substantial cumulative current account surpluses during the years in advance of the crisis (Truman 2009). Nevertheless, it was hit hard by a reversal of the gross inflows of capital to Korea that were a feature of the immediately preceding years. One consequence was the Bank of Korea took advantage of the Federal Reserve‘s offer to open a $30 billion swap line that the bank could use to support financial institutions needing to repay US dollar borrowings. The Federal Reserve opened similar lines with the central banks of Brazil, Mexico, and Singapore; the Bank of Mexico drew on its line, but the Central Bank of Brazil and the Monetary Authority of Singapore did not. Mexico along with Colombia and Poland also took advantage of the flexible credit line (FCL) put in place by the IMF in March of 2009.

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