Developing Economies

Is 'Excessive Optimism' the New Irrational Exuberance?

It sounds like a nice problem to have: Everybody in the world wants to give you money.

But when foreign investors rush into a developing country, they can drive local prices rise to crazy heights. Bubbles like that make messes when they pop.

In other words, some IMF economists said in a report published Friday:

Concerns that foreign investors may be subject to herd behavior, and suffer from excessive optimism, have grown stronger; and even when flows are fundamentally sound, it is recognized that they may contribute to collateral damage, including bubbles and asset booms and busts.

Countries that want to reduce the risk of this sort of problem have some options. They can make rules limiting loans from foreign investors, or tax investments that come into the country from overseas.

These sorts of moves have long been discouraged by IMF economists. Back in the '90s, the Economist notes, the IMF wanted the authority to push for more open flows of money into and out of countries.

The new IMF paper, though, says restrictions on investments by foreigners can be helpful in certain circumstances. The evidence from the latest crisis is not entirely clear. But it looks like these sorts of rules may help some economies weather turbulent times, the authors say.

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