Fiscal Policy Management in an Open Capital Regime

Much has been written since the Mexican crisis of late 1994 caused policy makers to reexamine their approach to conducting macroeconomic policy in an increasingly globalized world. The potential swiftness of capital flow movements, their heightened sensitivity to changed expectations, and the relative transactional ease with which movements can occur suggest the growing complexity of the institutional environment facing policy makers. In times of crisis, monetary policy measures normally represent the first line of defense in responding to a significant change in capital flows. However, authorities are often unwilling to allow significant exchange rate adjustments. Hence, there are obvious limits to the role that monetary policy can play beyond the short term. Even where a country's fiscal policy is not an obvious factor causing a shift in capital flows, it may be asked to play an important part in the overall macroeconomic policy response, despite the unavoidable delays inherent in adopting and implementing fiscal measures.