Free Capital Mobility Research Articles

Financial Globalization and Vulnerabilities:

This paper examines and measures the state of external financial openness and financial integration of Bangladesh and the impact of external policy changes and financial integration on the economic growth of Bangladesh. This study also focuses on the experiencesof crisis affected economies for identifying vulnerabilities of reforming Bangladesh under free capital mobility in near future.

A Tale of Two Trilemmas: Comparing the International Monetary and Financial Trilemmas

We critically analyze and compare the analytical structures of the international monetary and financial trilemmas. The first structure says that countries cannot have all three of fixed exchange rates, free capital mobility, and monetary autonomy. The second argues that countries cannot have all three of financial globalization, absence of financial crises, and financial autonomy. While the monetary trilemma is often described as being based on the Mundell–Fleming model, this is true only under the assumption of perfect capital mobility. Imperfect mobility can be caused by factors other than capital controls and in this case the constraints of the monetary trilemma need not be binding in the short run. In order to have a mechanism to provide balance of payments equilibrium, however, the theory of economic policy demonstrates that the monetary trilemma must be binding in the long run. While pointing to an important issue the financial trilemma formulation does not provide the most useful way to analyze the tradeoffs generated by financial globalization. More useful for this purpose is the literature on international externalities and public goods. We also argue that for many countries, giving up monetary autonomy will be more costly than giving up financial policy autonomy.

The monetary policy trilemma from the perspective of European integration

AbstractFollowing the breakdown of the Bretton Woods agreement the international monetary system has operated based on floating exchange rate arrangements and free capital mobility. A most significant subsequent improvement has been the process of European monetary integration, from the institution of the European Monetary System to the Euro currency. The relationships between the short‐term interest rates of European Union (EU) countries and the United States suggest, that in the post‐Bretton Woods period the US dollar has held an important anchor currency role, while EU countries acquired considerable monetary policy independence. Further, the stronger relationships between the short‐term interest rates of EU countries and Germany may be viewed as a consequence of monetary unification. The econometric evidence provides important insights for the period following the adoption of the Euro, when European economies have in many instances been subject to heterogeneous shocks.

International reserves, economic crisis and monetary autonomy in Asia: a panel data analysis

ABSTRACT A country cannot simultaneously have an independent monetary policy, fixed exchange rate and freely mobile capital. This paper uses data from 10 Asian economies in recent years to investigate the macroeconomic trilemma. It makes special reference to the role of exchange rate regimes, capital controls, economic crisis, and international reserve holdings to analyse how interest rate changes in the centre country affect peripheral countries’ interest rates. The main findings support the existence of a macroeconomic trilemma. Moreover, we find that international reserves help to provide monetary autonomy with a buffer even under a fixed exchange rate and free capital mobility regime.

Capital flow volatility regimes and monetary policy dilemma: Evidence from New Zealand

Mundell–Fleming’s trilemma underlines tradeoffs among three things: stable exchange rates, independent monetary policy, and free capital mobility. Rey (2015) finds that the global financial cycle has transformed the “trilemma” into a “dilemma” that constrains monetary policy independence, regardless of the exchange rate regime. Complementary to the existing literature on this framework, we concentrate on the importance of the volatility regimes of capital flows. We estimate a structural Bayesian threshold vector autoregression (TVAR) on New Zealand quarterly data from 1997:I to 2020:IV. Having allowed for different volatility regimes, we find that the “dilemma” will always bind a small open economy like New Zealand. Not only does the amount of capital flow matter, but its volatility also causes substantial impacts. We also find that a contractionary monetary policy shock lowers capital flow volatility, but hinders real GDP growth in the high volatility regime.

The Mundell-Fleming Trilemma Combination on Middle-Income Countries

The Mundell-Fleming trilemma hypothesis stated that a country could not simultaneously achieve exchange rate stability, financial integration, and monetary independence. The fixed exchange rate policy, free capital mobility, and monetary independence are trade-offs and impossible to run simultaneously. This research aims to identify the combination of the Mundell-Fleming trilemma formed in middle-income countries. Using the panel ARDL model, we found that the Mundell-Fleming trilemma tends to converge in the short run. While on the long run, middle-income countries tend to choose monetary independence and financial integration, resulting in a less stable exchange rate, as mentioned in the hypothesis

Foreign Direct Investment in Neoclassical Theory of International Trade: A Conceptual Weak Spot

This article analyses the role of foreign direct investment (FDI) in neoclassical theory of trade with a focus on the relocation of production into low wage countries. The conceptual analysis shows that FDI not only constitutes a weak spot in comparative advantage theory, but also that the latter is incompatible with efficiency-seeking FDI—with significant implications for policy. In Ricardian and Heckscher-Ohlin models of trade, FDI is ruled out via the assumption of factor immobility. In models in which factor immobility is relaxed, the closest FDI comes to is a generic reference to capital imports and exports, which affect factor endowments and, therefore, comparative advantage. Due to the assumption that input factors are determined by wage-rental ratios, this leads to the condition that firms operating in advanced economies must produce more labor-intensively, if investing in facilities in low-wage countries. Efficiency and market-seeking FDI, which combines productive, capital-intensive modes of production with cheap labor to exploit unit labor cost differentials, is a theoretical and mathematical impossibility in this framework. This conceptual weakness questions the validity of conventional approaches to development policy, which largely rely on market liberalization and free capital mobility.

The open-economy ELB: Contractionary monetary easing and the trilemma

Contrary to Mundell's trilemma, we show that free capital mobility may prevent monetary policy from ensuring output stability even if the exchange rate is flexible due to the existence of an Effective Lower Bound. The ELB is an interest rate threshold below which monetary easing becomes contractionary because of adverse effects on credit supply. A tightening in global monetary and financial conditions increases the ELB and may force central banks to hike rates even though domestic economic activity contracts. We also show that the ELB gives rise to a novel inter-temporal trade-off for monetary policy and calls for using a broad range of policy tools to restore monetary transmission.

Climate Change Around the World

This paper builds a highly disaggregated, dynamic, general equilibrium model of interactions between the climate and the economy. The model consists of approximately 19,000 1-degree by 1-degree regions containing land. Regional climates (or average annual temperatures) respond differently to increases in the Earth's temperature, and regional productivity varies with regional temperature. Each region makes optimal consumption-savings decisions in response to its changing productivity in one of two extreme market structures: autarky and free capital mobility. The relationship between regional temperature and productivity has an inverse U-shape, calibrated so that the many-region model replicates estimates of aggregate global damages from climate change; the implied optimal temperature is approximately twelve degrees. The central result is that climate change affects regions very differently, with many regions gaining while others lose. Although a tax on carbon increases average welfare, there is a large disparity of views across regions, with both winners and losers. These findings depend very little on the structure of capital markets.

Determinants of Sterilisation using Trilemma Policy: A study in Qatar, Kuwait, Indonesia, and Japan

Trilemma policy is a concept of international economics in which it is impossible to gain all three variables at once or also known as Mundell-Fleming framework. Trilemma policies consist of independent monetary policy, exchange rate stability, and free capital mobility. By pursuing any two of the variables, it will shadow the other one. On the other hand, sterilisation is the policy which is set by the central bank to limit the effect of inflow and outflow of the capital money supply. Trilemma policy affected the sterilisation, which is the proxy by central bank reserve due to the latter that depends on the former. The purpose of this study is to find the relationship between trilemma policy and sterilisation. The sample of the study focused on four countries such as Qatar, Kuwait, Indonesia, and Japan by collecting monthly data from the year 2009 to 2017. At the end of this study, the findings will verify whether it is possible to maintain all the three variables in trilemma policy to achieve a stable economic condition by sterilisation.

Determinants of Sterilization using a Trilemma Policy: A study in Qatar, Kuwait, Indonesia and Japan

Trilemma policy refers to a concept of international economics that states it is impossible to gain all three variables at one time, which is also known as Mundell-Fleming framework. The trilemma policies consist of independent monetary policy, exchange rate stability, and free capital mobility. Pursuing any two of the variables will shadow the other one. Sterilization, on the other hand, reflects the policy set by Central Bank to limit the effects of inflow and outflow of capital money supply. Trilemma policy may influence sterilization, proxy by Central Bank Reserve, as the latter depends on the former. This study determined the relationship between trilemma policy and sterilization by placing focus on four nations, namely Qatar, Kuwait, Indonesia and Japan. Monthly data were gathered from 2009 to 2017. At the end of this research, the findings verified if it is “possible or not possible to maintain all the three variables in the trilemma policy to achieve a stable economic condition by way of sterilization.”

Trilemma, dilemma or 2.5-lemma in the transmission of monetary policy: evidence from a Markov-switching panel data model

ABSTRACT We examine the spill-over effects of interest rate transmission of United States monetary policy to peripheral countries with various exchange rate regimes and capital control management policies. To do so, we propose a two-state continuous-time hidden Markov-switching panel data model using an empirical framework based on the Taylor rule. We find peripheral countries with flexible exchange rates and free capital mobility respond differently to changes in short-term US interest rates under the two regimes based on interest rate volatility. Under the high volatility regime, peripheral countries respond to decreases but not to increases in short-term US interest rate. Under the low volatility regime, peripheral countries respond more strongly to an increase than a decrease in short-term US interest rate. In addition, peripheral countries under high volatility regimes respond more strongly than countries under low volatility regimes to a decrease in short-term US interest rate. In both volatility regimes, capital controls insulate the peripheral countries from changes in the short-term US interest rate regardless their exchange rate regimes.

The trilemma of expansionary monetary policy in the Euro area during the COVID-19 crisis

The economic crisis spurred by the Corona virus (COVID-19) confronts central banks worldwide with new kinds of challenges, as in many countries a stop in production and sales due to lock downs meets enormous fiscal and monetary impulses to overcome the crisis. In Europe the situation is more than ever complicated, as a multitude of monetary policy emergency measures implemented during the financial and European debt crisis of 2007 to 2012 are still in place, such as negative interest rates and central bank bond buying programs. Especially the bond buying programs have been intensified once more during the current Corona crisis. This article contributes to the existing knowledge by proposing a new theoretic trilemma model for the case of a monetary union. Accordingly, there exists a trade-off between stabilizing a monetary union, maintaining free capital mobility and reducing expansionary monetary policy. The results underscore the importance of resolving the trilemma without jeopardizing the currency and financial stability.

„Невъзможната трилема“ и анализ на нейната валидност чрез използване на метода на визуализацията чрез софтуер с изкуствен интелект

This research aims to visualize the "impossible trilemma", i. e. the impossibility of simultaneously having a fixed exchange rate, free movement of capital and an independent monetary policy, for every economy through the application ofartificial intelligence software. The advantages of visualization techniques are revealed. The explored countries are divided into the following panels: theEurozone countries, the developed European countries (DEC), the developed non-European countries (DNEC), the BRICS countries (Brazil, Russia, India, China and South Africa), the developing European countries and the Organizationof the Petroleum Exporting Countries (OPEC). The results of the research show a great level of confirmation of the trilemma for the developing economies and the developed non-European countries. This implies that there is a compromise between exchange rate stability, monetary independence, and free capital mobility.

Impact of Financial Liberalization on Current Account with Complementary Effect of Institution: A Global Evidence

Financial Liberalization in recent years is seen as a driver of economic growth. However, at the same time, many authors have argued that free capital mobility produces macroeconomic instability and contributes to financial vulnerability in emerging nations. For example, Stiglitz (2002) has argued that pressuring emerging and transition countries to relax controls on capital mobility during the 1990s was a huge mistake. The questions remain why some countries benefit from liberalization while some do not. We proposed that governance institutions may be the deciding factor in this regard. Where institutions' quality is weak, most of the foreign investment would be opportunistic and short term in nature, hence would huge outflows later on after liberalization. However, in the case of strong institutions, the investment would be in long term Greenfield projects, leading to sustainable returns. In this way surplus funds would be reinvested, relieving the pressure from the current account in the long run. To establish its empirical validity, an econometric analysis was performed, using data of 50 countries (40 developing) from 2009 to 2018. KAOPEN (Capital account openness based on IMF’s Exchange Arrangements and Exchange Restriction) was used as a proxy for financial liberalization along with institutions (WGI), and their impact on Current account (CA) was assessed using other variables like Inflation (CPI), Trade Openness (exports and imports as % of GDP), financial development (Deposit to GDP), and real GDP as control. The results suggested that liberalization seems to have a negative but insignificant effect on the Current account. Whereas, Institutions have a significant and positive effect. However, the interaction effect showed a negative complementarity of institutions in liberalization and CA relationship. This implies that strong institutions not only promote CA inflow ever in the long run but also decrease the effect of legalization on CA, meaning if the effect is negative, institutions would decrease its severity. Other interesting findings suggested that financial development has a negative and significant effect on CA. Hence, institutions seem to act as a crucial factor in solving the liberalization puzzle, and developing countries should make their governance institutions strong before opening up to the world.

OECD-Led Tax Reforms: A Prescription for a Less Competitive Economy

This note reviews May 2019 OECD framework agreement report, “OECD/G20 Inclusive Framework on BEPS: Progress Report July 2018-May 2019” on international taxation of the ‘digital economy’. The core conclusions of the review are: 1. The framework agreement proposals to-date represent complex, ambiguous and uncertainty-rich set of taxation reforms that pose serious questions about their potential effectiveness and impact on the advanced economies; 2. The framework agreement proposals represent a direct challenge to the national sovereignty over taxation and fiscal policies, including policies aimed at domestic economic development, support for the free capital mobility and promotion of the research and innovation-intensive growth; 3. The framework proposals represent a significant risk of skewing international markets institutions in favour of larger Multinational enterprises (MNCs) at the expense of smaller, younger and more competitive and more innovative firms; and 4. The framework proposals represent a significant risk of increasing monopolisation and monopsonisation of the modern economies.

Capital Flows and the Real Economy

The effects of capital inflows on the real exchange rate and the growth of output, consumption and investment were explored using data from Iceland from the first quarter of 1997 to the last quarter of 2018. The objective was to explore whether capital inflows, caused by domestic interest rates being higher than foreign interest rates, were expansionary indicating the presence of an international financial cycle in contrast to the predictions of the Mundell-Fleming model. The statistical analysis consisted of the estimation of a vector autoregression system, which is used to generate impulse response functions for the variables of interest. We found that an increase in the capital inflow into a currency area increased output, consumption and investment. It follows that higher domestic interest rates under free capital mobility can have an expansionary effect by encouraging capital inflows that cause real exchange rates to increase as well as output and private expenditures. These findings call for the use of two policy instruments in small, open economies. In addition to interest rates, there is a need for some restrictions on portfolio investments by foreign investors. The restrictions will weaken the exchange rate effects of changes in domestic and foreign interest rates, leaving the interest rate channel of monetary policy to respond to the real economy.

Exploring the effects of capital mobility on the saving–investment nexus: evidence from Icelandic historical data

ABSTRACTWe explore the effects of capital mobility on the relationship between saving and investment using historical data for Iceland. First, we analyse the saving–investment (S-I) correlation for the period of restricted capital mobility using data from 1960 and 1994. We then add a period of free capital mobility between 1994 and 2008 and estimate the correlation for the period 1960–2008. Finally, we extend our analysis to the 2008 to 2016 period, when capital controls were imposed in response to the crisis. Institutions matter: We find institutional changes, in particular, Iceland’s entry into the European Single Market in 1994, coincided with a fall in the long-run correlation between saving and investment. However, the correlation weakens further when we include the post-crisis regime of capital controls, suggesting a weaker relationship between savings and investment in this regime. We discuss the possible reasons for this pattern and also the implications of our findings for post-crisis policy in small open economies.

Currency carry trade and the cost of international reserves in Mexico

National strategies aimed at boosting economic growth following the global financial crisis have spawned monetary imbalances between industrial and emerging economies. By implementing ultra-expansionary monetary policies, the industrial economies drive down interest rates, while the emerging economies tighten their monetary policies by raising rates, thus generating a burgeoning foreign-currency carry trade. Vulnerability is caused by the sudden reversal of such capital flows or the high cost of insuring against this by accumulating reserves. This paper estimates that the cost of reserve accumulation between 2008 and 2014 averaged 1.83% of GDP, so the free capital mobility espoused by the Mexican authorities makes it very costly to play by the rules of financial globalization.

International Capital Movement and Monetary Independence in Asia

In this paper, we investigate the extent of monetary independence in a group of ten Asian countries: China, Malaysia, Japan, India, Indonesia, Philippines, Thailand, Korea, Singapore, and Hong Kong. While the traditional investigation has considered only the bivariate relationship between the home interest rate and the base rate, we employ both single-equation and vector autoregressive representations of the bivariate and the trivariate relationship including the desired (or optimal) interest rate. We find in most countries, that the ranking of monetary independence is relatively consistent across the models and methodologies although model specifications produce important differences for some countries such as Japan, Indonesia, and India. Trilemma suggests that a country cannot accomplish all three policy objectives: monetary independence, exchange rate stability, and free capital mobility. To increase monetary independence a country must choose between greater exchange rate flexibility or a lower degree of capital mobility. The fact that China and Malaysia, the two countries that are known to have imposed the strictest capital controls, consistently rank high in various scenarios while Hong Kong, which has maintained nearly the freest regime in capital markets, is lowest in monetary independence, indicates that perhaps capital controls may play a more important role than does exchange rate flexibility in securing independence in monetary policy making. On the other hand, countries that maintain greater exchange rate stability do not necessarily rank low, unless it is combined with greater capital mobility as in the case of Hong Kong.