Emerging markets are likely to be increasingly prone to asset price bubbles in coming years due to capital inflows from advanced economies and strong domestic saving, a top Bank of England official said on Saturday.
Andrew Haldane, the BoE's executive director for financial stability, said this trend was already evident in bubbly behavior in emerging markets in 2010 and meant there was growing international acceptance of capital controls.
Capital restrictions and macro-prudential policies have entered the policy bloodstream, if not yet the mainstream. The debate today is how best to integrate such tools into established macroeconomic policy frameworks, he said in a speech at a conference in Bretton Woods, New Hampshire.
Haldane's remarks come as BoE Governor Mervyn King prepares to travel to Washington next week for the International Monetary Fund's Spring meetings. On Tuesday the IMF endorsed capital controls after many years of opposition.
Haldane estimated that between 2010 and 2050, annual inflows into emerging markets within the G20 group, such as China, India and Brazil, would average 8 percent of these markets' market capitalization.
This compared to portfolio equity inflows of 4 percent of market capitalization in the three years before East Asian economies suffered a crisis in the late 1990s, he said.
Factors driving net inflows into emerging economies included the desire of investors in advanced economies to diversify their holdings while domestic investors in emerging economies maintained a bias toward keeping their investments at home.
Capital markets in emerging economies were small compared to those in advanced economies, and were unlikely to grow fast enough to be able to use efficiently the money being transferred from advanced economies.
Capturing that dynamic requires a different metaphor, the 'big fish, small pond' problem, Haldane said.
He did not specify what kind of capital controls were desirable, but said they did not differ fundamentally from the macro-prudential measures that were gaining favor in advanced economies since the financial crisis.
Among the thorny issues policymakers needed to decide was whether capital controls should be used as a temporary last resort when other policy measures had failed, or as a permanent accompaniment to more normal measures.
Other issues included whether capital controls should distinguish between long-term foreign direct investment and short-term flows, and whether the IMF should impose rules or leave it up to individual countries, he added.
(Editing by Ron Askew)