Global liquidity could potentially lead to over-heating through augmenting domestic liquidity; loss of competitiveness through exchange rate appreciation; and increased vulnerability to crisis through spillover to various segments of financial sector. Furthermore, fluctuations in global liquidity make capital flows to EMEs more unstable.
This in turn makes it difficult for policymakers to assess and distinguish between the durable and transitory components of capital flows, constraining their ability to effectively pursue domestic policy objectives. In short, capital flows inconsistent with domestic absorptive capacities in EMEs complicate macroeconomic management.