Capital Flow Shocks Research Articles

Capital Flows and Foreign Exchange Intervention

I consider a New Keynesian model of a small open economy where international financial markets are imperfect and the exchange rate is determined by capital flows. I use this framework to study the effects of exchange rate fluctuations driven by capital flows and characterize the optimal foreign exchange intervention. Capital flow shocks cause inefficient exchange rate fluctuations that trigger boom-bust cycles in the domestic economy. The optimal policy response is to use both foreign exchange intervention and monetary policy to stabilize the economy. Foreign exchange intervention “leans against the wind” and stabilizes the path of the exchange rate, while monetary policy corrects the inefficiencies caused by price rigidity. The two tools are complements rather than substitutes. I derive the optimal foreign exchange intervention rule in closed form as a function of three implicit targets: a wedge in the Bakus-Smith condition, domestic net foreign assets, and the level of foreign reserves.

Dynamic Effects of Capital Flow Shocks upon Stock Market Developments in Nigeria

Aims: To analyze the dependent relationship between capital flow and stock market development in Nigeria. Study Design: case study (Nigeria) Methodology: the study employed the use of Vector Auto-regression Model (Granger ‐ Causality Wald Test, Impulse Response Test and Variance Decomposition Test), to enable us achieve our objectives. Scope of the Study: 1986 ‐ 2012. Results: the granger causality result shows that Capital Account Balance (Deju), Foreign direct investment (FDIN), Net portfolio investment (NPI), Real gross domestic product

DYNAMIC EFFECTS OF FOREIGN DIRECT INVESTMENT WHEN CREDIT MARKETS ARE IMPERFECT

This paper argues that foreign direct investment (FDI) may increase the vulnerability to capital flow shocks of economies with credit market imperfections. Because of worse access to financial markets, wages in domestic firms carry higher default risk than wages in foreign ones. This alters the domestic wage composition and the subsequent wealth distribution. When credit markets are imperfect, the wealth distribution typically determines an economy's growth potential in autarky; hence, high exposure to FDI may significantly impede the capability to recover from sudden withdrawals of foreign capital. This appears consistent with a first glance at empirical evidence on durations of output recovery after systemic sudden stops.

Threshold Effects of Foreign Reserve Holdings in Developing Countries

Foreign reserves play an important role in insuring developing countries against exogenous shocks and reducing the probability of panic driven crisis. While the literature on foreign reserves has so far focused on determining the ‘required’ or ‘optimal’ level of reserves based on various parameters such as volatility of export revenues, opportunity cost of holding reserves etc., little attention has been paid to the impact of reserve holdings in the event of shocks. This paper tries to bring some insight in to the role of reserves in shaping the response of developing countries to exogenous price and capital flow shocks. We find important threshold effects of reserves on the behavior of key macro variables in the face of exogenous shocks. Ignoring these effects would provide us with misleading results regarding the cost of exogenous shocks and adequacy of reserve levels.

INTERNATIONAL CAPITAL FLOWS, BOOM‐BUST CYCLES, AND BUSINESS CYCLE SYNCHRONIZATION IN THE ASIA PACIFIC REGION

This article documents evidence of business cycle synchronization in selected Asia Pacific countries since the 1990s. We explain business cycle synchronization by the channel of international capital flows and boom‐bust cycles. Using the vector auto‐regression method, we find that most Asian countries experience boom‐bust cycles following capital inflows, where the boom in output is mostly driven by consumption and investment. Empirical evidence also shows that capital flow shocks are positively correlated in the region, which supports the conclusion that capital market liberalization has contributed to business cycle synchronization. (JEL F4)

Monetary Policy, Capital Inflows and the Housing Boom

A range of hypotheses have been put forward to explain the boom in house prices that occurred in the United States from the mid-1990s to 2007. This paper considers the relative importance of two of these hypotheses. First, global imbalances increased liquidity in the US financial system, driving down long-term real interest rates. Second, the Federal Reserve kept interest rates low in the first half of the 2000s. Both factors reduced the cost of borrowing and may have encouraged the boom in house prices. This paper develops an empirical framework to separate the relative contributions of these two factors to the US housing market. The results suggest that capital inflows to the United States played a bigger role in generating the increase in house prices than monetary policy loosening. Using VAR methods, we find that compared to monetary policy, the effect of a capital inflows shock on US house prices and residential investment is about twice as large and substantially more persistent. Results from variance decompositions suggest that, at a forecast horizon of 20 quarters, capital flows shocks explain 15% of the variation in real house prices, while monetary policy shocks explain only 5%. In a simple counterfactual exercise, we find that if the ratio of the current account deficit to GDP had remained constant since the end of 1998, real house prices by the end of 2007 would have been 13% lower. Similar exercises with constant policy rates and the path of policy rates implied by the Taylor rule deliver smaller effects.

Research on the Quantitative Dynamic Structure of Shocks in Macroeconomics Business Cycle

In this paper, we attempt to study quantitatively the effects on macroeconomics due to different shocks. The interactions between different shocks are the major subjects. Furthermore, the dynamics of shocks, i.e, the time evolutions of shocks, and the propagation of shocks are studied in detail by using the quantitative models. The approach of this paper can be applied to any economic shocks, particularly, price shocks, technology shocks, unemployment shocks, and outer capital flow shocks. As an example, we investigate the interaction of price shock and exchange rate shock. At the same time, we also discuss the macroeconomic policy's effects on economic business cycle.

Research on the Quantitative Dynamic Structure of Shocks in Macroeconomics Business Cycle

In this paper, we attempt to study quantitatively the effects on macroeconomics due to different shocks. Theinteractions between different shocks are the major subjects. Furthermore, the dynamics of shocks, i.e, the timeevolutions of shocks, and the propagation of shocks are studied in detail by using the quantitative models. Theapproach of this paper can be applied to any economic shocks, particularly, price shocks, technology shocks,unemployment shocks, and outer capital flow shocks. As an example, we investigate the interaction of priceshock and exchange rate shock. At the same time, we also discuss the macroeconomic policy’s effects oneconomic business cycle.

Capital Flows and Economic Fluctuations: The Role of Commercials Banks in Transmitting Shocks

This paper uses a general equilibrium model to examine the central role played by commercial banks in intermediating and amplifying the capital flow shocks to the local economy in the 1997 Asia financial crisis. It finds that a sudden stop of capital inflows affects the equilibrium credit supply through two channels: first, the plunge of foreign financing decreases the loanable funds directly; and second the sudden stop drives up the cost of providing banking services, thereby additionally reducing the available bank credit to firms through a deposit run. Empirical results from a VAR model broadly support the theoretical implications.

Dollarization and economic performance: What do we really know?

AbstractIn this paper we analyse the macroeconomic record of dollarized economies. In particular, we investigate whether, as its supporters claim, dollarization is associated with lower inflation and faster growth. We analyse this issue by using a matching estimator technique developed in the training evaluation literature. Our findings suggest that inflation has been significantly lower in dollarized nations than in non‐dollarized ones. We also find that dollarized nations have had a lower rate of economic growth than non‐dollarized ones. Finally, we find that macroeconomic volatility is not significantly different across dollarized and non‐dollarized economies. We conjecture that the lower rate of economic growth in dollarized countries is due, at least in part, to these countries' difficulties in accommodating external disturbances, such as major terms of trade and capital flows shocks. Copyright © 2003 John Wiley & Sons, Ltd.

The Behavior of the Real Exchange Rate Under Fixed and Floating Exchange Rate Regimes

This article investigates the behavior of real exchange rates under fixed and flexible exchange rates. Using data from both the Bretton Woods and the modern floating periods, we decompose real exchange rate movements into components attributable to supply shocks, real demand shocks, monetary shocks, capital flows shocks, and real oil price shocks. Empirical results show that real demand shocks are an important source of real exchange rate movements under both fixed and flexible rates, while monetary shocks are negligible. Supply and oil price shocks seem to be more important under Bretton Woods, while capital flows shocks seem to explain a relatively higher proportion of real exchange rate movements under the modern floating period.