Capital flows, the carry trade and 'sand in the wheels'

• Stephen Grenville
• Lowy Institute for International Policy

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08 February 2010The 'carry trade', in which capital shifts from countries with low interest rates to countries with significantly higher rates, has become an important element of international capital flows over the past decade. In a new Lowy Institute Policy Brief, Dr Stephen Grenville looks at the challenges raised by these capital flows for economic policy.

The Global Financial Crisis 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. Dr Grenville proposes that these countries should explore ways of discouraging these short-term inflows, and in doing this should have the backing of the IMF.