Capital account
A deficit in the capital account means money is flowing out of the country, and it suggests the nation is increasing its ownership of foreign assets.
The term "capital account" is used with a narrower meaning by the International Monetary Fund (IMF) and affiliated sources.
Setting a higher interest rate than other major central banks will tend to attract funds via the nation's capital account, and this will act to raise the value of its currency.
[5] In the absence of foreign reserves, central banks may affect international pricing indirectly by selling assets (usually government bonds) domestically, which, however, diminishes liquidity in the economy and may lead to deflation.
When a currency rises higher than monetary authorities might like (making exports less competitive internationally), it is usually considered relatively easy for an independent central bank to counter this.
A third mechanism that central banks and governments can use to raise or lower the value of their currency is simply to talk it up or down, by hinting at future action that may discourage speculators.
[6][7] In the financial literature, sterilization is a term commonly used to refer to operations of a central bank that mitigate the potentially undesirable effects of inbound capital: currency appreciation and inflation.
The classic way to sterilize the inflationary effect of the extra money flowing into the domestic base from the capital account is for the central bank to use open market operations where it sells bonds domestically, thereby soaking up new cash that would otherwise circulate around the home economy.
[8] A central bank normally makes a small loss from its overall sterilization operations, as the interest it earns from buying foreign assets to prevent appreciation is usually less than what it has to pay out on the bonds it issues domestically to check inflation.
[9] In the strict textbook definition, sterilization refers only to measures aimed at keeping the domestic monetary base stable; an intervention to prevent currency appreciation that involved merely buying foreign assets without counteracting the resulting increase of the domestic money supply would not count as sterilization.
The above definition is the one most widely used in economic literature,[10] in the financial press, by corporate and government analysts (except when they are reporting to the IMF), and by the World Bank.
The largest type of transfer between nations is typically foreign aid, but that is mostly recorded in the current account.
When a country receives significant debt forgiveness, that will typically comprise the bulk of its overall IMF capital account entry for that year.
The IMF's capital account does include some non-transfer flows, which are sales involving non-financial and non-produced assets—for example, natural resources like land, leases and licenses, and marketing assets such as brands—but the sums involved are typically very small, as most movement in these items occurs when both seller and buyer are of the same nationality.
While usually aimed at the financial sector, controls can affect ordinary citizens, for example in the 1960s British families were at one point restricted from taking more than £50 with them out of the country for their foreign holidays.
John Maynard Keynes, one of the architects of the Bretton Woods system, considered capital controls to be a permanent part of the global economy.
[14] Both advanced and emerging nations adopted controls; in basic theory it may be supposed that large inbound investments will speed an emerging economy's development, but empirical evidence suggests this does not reliably occur, and in fact large capital inflows can hurt a nation's economic development by causing its currency to appreciate, by contributing to inflation, and by causing an unsustainable "bubble" of economic activity that often precedes financial crisis.
[13][15][16] As part of the displacement of Keynesianism in favor of free market orientated policies, countries began abolishing their capital controls, starting between 1973–74 with the US, Canada, Germany and Switzerland and followed by Great Britain in 1979.
[15] An exception to this trend was Malaysia, which in 1998 imposed capital controls in the wake of the 1997 Asian Financial Crisis.
[19] By the second half of 2009, low interest rates and other aspects of the government led response to the global crises had resulted in increased movement of capital back towards emerging economies.
