Curbing the carry trade

A couple of weeks back I suggested that exchange rates were going to be a big policy theme this year. In a piece for the FT a few days ago, Gillian Tett makes a similar point in the context of the recently concluded annual Davos beanfest, predicting that by the time of the 2011 gathering, 'the next big bogeyman may be exchange rates'.

In my January post I listed a few examples of policy challenges linked to exchange rates, but an important one that I didn't include was the carry trade, which is also exercising policymakers' minds this year.

My colleague Steve Grenville has an interesting new paper on our website which looks at some of these issues. Steve argues that the GFC will leave a legacy of substantial interest differentials between the slow-growing crisis countries and the emerging markets. This is likely to attract big short-term volatile capital flows which will push up exchange rates and leave these countries vulnerable to sudden outflows. He proposes that these countries should explore ways of discouraging these short-term inflows, and in doing this should have the backing of the IMF.

Photo by Flickr user carioca_san, used under a Creative Commons license.