The Effects of Short-Term Capital Flows on Exchange Rates in Intermediate and Flexible Exchange Rate Regimes: Empirical Evidence from Turkey

Abuzer Pinar,Bahar Erdal

doi:10.5539/ibr.v8n10p93

Abstract

The aim of this paper is to analyze empirically the effects of short-term capital flows on exchange rates in Turkey under intermediate and flexible exchange rate regimes. In this framework, the periods where intermediate (January 1994-February 2001) and flexible (March 2001-September 2012) exchange rate regimes implemented in Turkey were taken as a base. The estimation results show that foreign exchange rate regimes are significant factors for the effects of short-term capital flows on exchange rates. While the short-term capital flows have significant effects on exchange rates in the flexible exchange rate regime, they have no significant effects on exchange rates in the intermediate exchange rate regimes. In the intermediate exchange rate regimes, price differentials have significant effects on exchange rates. These empirical results are consistent with the theory.

Highlights

Economic theory suggests that capital will move from countries where it is abundant to countries where it is scarce because the returns on new investment opportunities are higher where the capital is limited
This study investigates the effects of short-term capital flows on exchange rates under different exchange rate regimes
This may not be a problem during the period when the purchasing power parity (PPP) theory was developed since the volume of international capital movements were not very large

Summary

Introduction

Economic theory suggests that capital will move from countries where it is abundant to countries where it is scarce because the returns on new investment opportunities are higher where the capital is limited. Combes, Kinda, and Plane (2011) investigates the effects of different forms of private capital flows on the real effective exchange rate using a sample of 42 developing countries for the period 1980 to 2006 They find that short-term capital flows, especially portfolio investment has the highest appreciation effect, seven times that of foreign direct investment (FDI) and bank loans and private transfers have the least effect. Ersoy (2013) investigates the role of capital inflows and the exchange market pressure on the real exchange rate appreciation in Turkey for the period January 1992 to September 2007 He finds that while FDI and worker’s remittances do not have a positive effect on real exchange rate appreciation, portfolio investment liabilities and banks’ foreign currency liabilities cause real exchange rate appreciation.

History of Short-Term Capital Flows in Turkey

Foreign Exchange Rate Regimes in Turkey

Theoretical Model

Data and Empirical Results

Conclusion