In the 1990s, significant capital inflows occurred into developing countries, particularly in Asia and Latin America, with about US$460 billion flowing in five years (1990-94), compared to US$133 in the previous five years. These inflows often led to monetary expansion, inflation, real exchange rate appreciation, and widening current account deficits. The paper explores the causes and effects of these inflows, emphasizing both external and internal factors. External factors included falling U.S. interest rates, a recession in industrial countries, and improved creditworthiness of debtor countries. Internal factors included sound domestic policies, institutional reforms, and credible increases in returns on investment. The surge in capital inflows was driven by a combination of these factors, including the sustained decline in world interest rates, international diversification of investments, improved relations with external creditors, and sound monetary and fiscal policies. The paper discusses the macroeconomic effects of these inflows, including increased consumption and investment, real money balances, foreign exchange reserves, real exchange rate appreciation, and current account deficits. It also highlights the vulnerability of developing countries to abrupt reversals of capital flows and the need for policies to mitigate these risks. Policy responses included sterilization of capital inflows, exchange rate policies, and fiscal adjustments. Sterilization, while aimed at controlling inflation and exchange rates, can be costly and may lead to increased public debt. Exchange rate policies, such as allowing greater flexibility, can help manage inflation but may also lead to real exchange rate appreciation. Fiscal policies, including tightening public expenditures, can help limit real exchange rate appreciation but may have limited effectiveness if not perceived as temporary. The paper concludes that the policy choices for small open economies facing capital inflows are limited, and that the effectiveness of policies in reducing vulnerability to reversals remains uncertain. The role of external factors, the nature of capital flows, and the composition of aggregate demand are key in determining the real exchange rate response to capital inflows. Future research should focus on understanding the forces driving cycles in foreign lending and improving measures of credibility and risk.In the 1990s, significant capital inflows occurred into developing countries, particularly in Asia and Latin America, with about US$460 billion flowing in five years (1990-94), compared to US$133 in the previous five years. These inflows often led to monetary expansion, inflation, real exchange rate appreciation, and widening current account deficits. The paper explores the causes and effects of these inflows, emphasizing both external and internal factors. External factors included falling U.S. interest rates, a recession in industrial countries, and improved creditworthiness of debtor countries. Internal factors included sound domestic policies, institutional reforms, and credible increases in returns on investment. The surge in capital inflows was driven by a combination of these factors, including the sustained decline in world interest rates, international diversification of investments, improved relations with external creditors, and sound monetary and fiscal policies. The paper discusses the macroeconomic effects of these inflows, including increased consumption and investment, real money balances, foreign exchange reserves, real exchange rate appreciation, and current account deficits. It also highlights the vulnerability of developing countries to abrupt reversals of capital flows and the need for policies to mitigate these risks. Policy responses included sterilization of capital inflows, exchange rate policies, and fiscal adjustments. Sterilization, while aimed at controlling inflation and exchange rates, can be costly and may lead to increased public debt. Exchange rate policies, such as allowing greater flexibility, can help manage inflation but may also lead to real exchange rate appreciation. Fiscal policies, including tightening public expenditures, can help limit real exchange rate appreciation but may have limited effectiveness if not perceived as temporary. The paper concludes that the policy choices for small open economies facing capital inflows are limited, and that the effectiveness of policies in reducing vulnerability to reversals remains uncertain. The role of external factors, the nature of capital flows, and the composition of aggregate demand are key in determining the real exchange rate response to capital inflows. Future research should focus on understanding the forces driving cycles in foreign lending and improving measures of credibility and risk.