Self-Insurance or Self-Destruction?

NEW DELHI – Though the US Federal Reserve is turning a blind eye to the spillover effects of its monetary policy, the rest of the world is worrying about the impact that capital-flow reversals will have on emerging economies. Will the foreign reserves that these countries have built up in recent years prove adequate to protect their financial systems, as liquidity flows back toward developed economies?

The short answer is no, because excessive self-insurance ultimately does more harm than good. In order to break the destabilizing cycle of short-term capital flows and excessive accumulation of foreign reserves, the International Monetary Fund, with broad support from the G-20, must devise new rules regarding monetary-policy spillovers.