In both cases, there were harsh criticisms by the international community, which deemed the measures as undermining the benefits of free markets. Fast forward to 2008, a generalized downward spiral in asset prices and abrupt market seizures were contained by extraordinary interventions of major central banks, particularly the Federal Reserve. The interventions were far reaching, ranging from loans to banks and non-banks to direct support of private securities, such as commercial paper and mortgagebacked securities. In effect, central banks became market makers in some segments of the market. These interventions were widely applauded. What a difference a decade makes! In the wake of the global financial crisis, an emerging consensus is that market interventions in certain circumstances are justified. No more is this evident than with respect to the use of capital flow measures, or CFMs. It is now generally accepted that CFMs targeted at tilting the composition of inflows away from debt, especially short-term ones, can be beneficial. More generally, macroprudential measures have become an important part of policymakers toolkit, with increasing theoretical support for their use in a counter-cyclical manner. A similar reassessment has occurred with respect to foreign currency intervention, which is increasingly being recognized as a useful and justifiable complementary tool. Also, the large accumulation of foreign reserves that was once criticized is now credited with helping to mitigate the impact of the global financial crisis on emerging market countries. Thus much of what Asia was doing before on the fringe, so to speak, have now become mainstream.

Nevertheless, there are important reasons why capital flow volatility and exchange rate fluctuations may present more challenges for emerging market countries. For one, less developed and relatively shallow financial markets means that asset prices will move more in response to capital flow volatility. Secondly, greater reliance on exports as an engine of growth implies more susceptibility to currency movements. Thirdly, many emerging market countries have had a long history with fixed exchange rates, which translates both into less familiarity with hedging instruments as well as greater political pressure in the face of exchange rate fluctuations. Finally, weaker governance and institutions means that inflows may be more likely to cause imbalances during booms. These very same weaknesses also tend to make investors more fickle to exit when things turn sour. Of course none of this is entirely new. Dealing with capital flow waves or “bonanzas” have been a perennial challenge for emerging market countries. It is old wine in a new bottle. What is new this time around is that the degree of financial integration across countries is unprecedented, as is the global monetary policy context characterized by advanced economies simultaneously pushing the accelerator to the floor and keeping it there. There are legitimate concerns whether the bottle will break this time around. Which brings me to the question of how to deal with these challenges. If you were an alien observing all this from Mars, it might seem obvious that there are important coordination failures at the global level.