6. Sterilization and the Capital Inflow Problem in East Asia, 1987–97

Abstract

During the capital inflow episode of 1987 97, the monetary authorities of East Asia (i.e., Indonesia, Korea, Malaysia, the Philippines and Thailand) took various measure to sterilize the expansionary effect of reserve inflows on the growth of monetary aggregates. Econometric tests based on quarterly data suggest that the set of various sterilization measures pursued were effective in limiting the growth of narrow and broad money. This may have promoted additional capital inflows by keeping the level of domestic interest rates high, or caused disintermediation and expanded the volume of assets in the poorly supervised nonbank financial sector. In either case, the potential risk of capital inflows in East Asia was likely magnified by the active policy of sterilization. 1 The authors thank Leonard Cheng, Takatoshi Ito, Ryuzo Miyao, Carmen Reinhart, Hiroshi Shibuya, Kazuo Yokokawa and Mahani Zainal-Abidin for useful comments. Needless to say, the authors alone assume responsibility for any remaining errors. The views expressed in the paper do not necessarily reflect those of the Economic Planning Agency or the Government of Japan. 2 Osaka University 3 Osaka University