Macro-prudential Response to Increased Global Market Volatility

Abstract

The volatility of price indicators has remained extremely stable during the period of low interest rates since the Global Financial Crisis (GFC) of September 2009. Low volatility pushes down risk premium, which can cause an upturn in global investors’ risk appetite. There has been a big change in global liquidity flows since 2009. Emerging market economies (EMEs), with relatively high credit risk, received huge capital inflows backed by the escalated risk appetite of global investors. The US Federal Reserve is now trying to normalize its monetary policy by pushing up the policy rate, tied at zero lower bound for about seven years. In December 2015, the Federal Reserve raised interest rates for the first time in nine years. This will bring about asset price volatility and cause risk premiums to normalize. We remain concerned about the downside risk to capital outflows from EMEs, including Korea. And this may well potentially cause a decrease in asset price and growth contraction in EMEs. Accordingly, we provide an overview of the volatility of financial markets and new trends in capital flows, and identify the determinants of capital flows to/from EMEs. We also review the use of capital flow management policies in EMEs including Korea, and examine the effectiveness of Asset-Based Reserve Requirements (ABRR) as an alternative macro-prudential policy measure to manage capital flows.