Limited Capital Mobility Research Articles

AN ASSESSMENT OF THE FELDSTEIN–HORIOKA PUZZLE FOR INDIA: A MARKOV REGIME SWITCHING APPROACH

The study aims to examine the Feldstein–Horioka puzzle in the Indian context during 2002Q2 to 2019Q4 to unearth nonlinear patterns in the data. Findings from an augmented Markov regime-switching model reveal two distinct, yet random regimes for correlations between savings and investment-GDP ratios, with higher correlation between the variables persisting for a longer duration. In the low correlation regime, trade-related factors, policy uncertainty and global shocks have a significant impact on the correlation. Fiscal shocks and trade costs explain high correlations in regime 2, while global shocks act to decrease the correlation in this regime. The high correlation regime dominates the study period and indicates that the Feldstein–Horioka puzzle of limited capital mobility persists in India. Economic agents appear to respond rapidly to changing domestic and global policy conditions, besides being affected by incomplete integration of goods markets, explaining the pattern of correlations.

Inventory as a Financial Instrument: Evidence from China’s Metal Industries

Classic inventory theory suggests that inventory plays a vital role in matching demand and supply. This paper provides both country- and firm-level evidence that inventory can be used as a financial instrument to take advantage of arbitrage opportunities in financial markets with limited capital mobility. Using data from China customs’ metal imports and firm-level inventory from metal processing industries, we show that firms can utilize the inventory of an imported product to carry lower cost capital into a country with strict capital controls and, thus, gain higher financial returns. Specifically, at the country level, we find that the level of imported metal commodities is positively associated with the expected returns from financial arbitrage. At the firm level, we find that a higher expected return from financial arbitrage will incentivize a firm to increase its inventory level through short-term borrowing. In addition, our evidence supports the notion that firms with higher liquidation value, larger size, and higher sales growth (i.e., firms with higher borrowing capacity) may be more active in using inventory as an instrument to seek higher financial gains. We also utilize a unique regulatory policy shock as a quasi-natural experiment to enhance the causality interpretation of our empirical findings. This paper was accepted by Vishal Gaur, operations management. Funding: This work was supported in part by the National Natural Science Foundation of China [Grant 72201230] and the Research Grants Council of Hong Kong, University Grants Committee [Grant 14504621]. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2023.4873 .

A Theory of Foreign Exchange Interventions

We develop a theory of foreign exchange interventions in the presence of limited capital mobility. We study a real small open economy subject to global liquidity and endowment shocks. Home and foreign bond markets are segmented and intermediaries have a limited capacity to arbitrage between both bond markets. As a result, the central bank can manipulate the spread across markets by managing its portfolio. We show that the planning problem can be entirely framed in terms of the spreads. Crucially, spreads are inherently costly, over and above the standard costs from distorting households’ consumption profiles. The extra term is exactly given by the carry trade profits of foreign intermediaries, is convex in the spread - as more foreign intermediaries become active carry traders - and increasing in the openness of the capital account - as foreign intermediaries find it easier to take larger positions. Optimal interventions lean against the wind for global liquidity shocks and implement a zero spread against endowment shocks. Importantly, interventions should be small, frequent and rely on forward guidance of future interventions. The effectiveness of interventions increases if they are pre-announced and the policy is more credible. Finally, we model a world equilibrium with two types of small open economies: advanced economies, with a strong desire to save; and emerging markets, who intervene to avoid currency appreciation. In the Nash equilibrium, emerging markets engage in “reserve wars,” leading to substantial reserve over-accumulation and too depressed world interest rates. Simple coordination rules, like committing to replicating zero spreads, are shown to be strict Pareto improvements for reasonable calibrations.

Measure of Macroeconomics of CFA Zone Countries Compare to SSA Countries

The research is financed by the school of finance and economics of Jiangsu University (+86 511 8878 0011) Abstract The influence of services activity in the economic development regarding the macroeconomics tactics and application. We investigate the sources of macroeconomics fluctuations in Sub-Saharan African (SSA) countries with particular attention to the development growth, federal investment, gross national income and consumer price with a structural Vector Auto regression (VAR) model with limited capital mobility and long run restrictions to identify the shocks. The research data analyzed by Linear square, in the first step data has been manipulated by level of stationary in first root and then with unit root individually classify the regions distribution with each expects to estimation development and confirm that even though the development techniques by individual development of SSA. However, terms of growth intention and development tend to influence the CFA zone to a greater extent and there seems to be a higher influence of demand shocks on output and the federal investment and consumer prices in the non-CFA countries. Supply and terms of trade shocks tend to dominate output movements in the CFA and non-CFA countries alike. Keywords: Economic development; SSA and CFA; macroeconomics DOI: 10.7176/RJFA/11-4-11 Publication date: February 29 th 2020

The Financing Role of Inventory: Evidence from China’s Metal Industries

Classical inventory theory suggests that inventory plays a vital role in matching demand and supply. This paper provides both macro and micro evidence that inventory can be used as a financial instrument to take advantage of arbitrage opportunities in financial markets with limited capital mobility. Using data from China’s country-level metal commodity imports and firm-level inventory from metal processing industries (with metal commodities as primary inputs), we show that firms can utilize the inventory of an imported product to carry lower-cost capital into a country with strict capital controls and thus gain higher financial returns. Specifically, at the country-level, we show that levels of imported metal commodities are positively associated with the expected returns from financial arbitrage. At the firm-level, we find that a higher expected return from financial arbitrage will incentivize a firm to increase its inventory level through increased short- term borrowing. In addition, firms with higher borrowing capacity, larger size, or higher sales growth are more active in using inventory as an instrument to seek higher financial gains. We also utilize a unique regulatory policy shock as a natural experiment to establish causality in our empirical analysis.

Comments by Bhanupong Nidhiprabha, on Exchange Rate Flexibility, Financial Market Openness, and Economic Growth

February 01 2018 Comments by Bhanupong Nidhiprabha, on Exchange Rate Flexibility, Financial Market Openness, and Economic Growth Author and Article Information Online Issn: 1536-0083 Print Issn: 1535-3516 © 2018 by the Asian Economic Panel and the Massachusetts Institute of Technology2018Massachusetts Institute of Technology Asian Economic Papers (2018) 17 (1): 165–167. https://doi.org/10.1162/asep_a_00597 Cite Icon Cite Permissions Share Icon Share Facebook Twitter LinkedIn MailTo Views Icon Views Article contents Figures & tables Video Audio Supplementary Data Peer Review Search Site Citation Comments by Bhanupong Nidhiprabha, on Exchange Rate Flexibility, Financial Market Openness, and Economic Growth. Asian Economic Papers 2018; 17 (1): 165–167. doi: https://doi.org/10.1162/asep_a_00597 Download citation file: Ris (Zotero) Reference Manager EasyBib Bookends Mendeley Papers EndNote RefWorks BibTex toolbar search Search Dropdown Menu toolbar search search input Search input auto suggest filter your search All ContentAll JournalsAsian Economic Papers Search Advanced Search Bhanupong Nidhiprabha: The paper's main hypothesis is based on the notion that exchange rate fluctuations can affect economic growth. The impact of exchange rate changes on output growth can help or hamper economic growth, depending on the level of the country's degree of financial openness. The main conclusion of the paper is derived from Table 2, which reports the regression result from estimating equation (1). The authors focus on the impact of exchange rate flexibility on per capita output, which varies with the degree of financial market openness. This implies that the volatile exchange rates hamper economic growth when the financial market openness is low, due to capital control. In other words, a country with limited capital mobility would not be able to grow fast if it is under a flexible exchange rate regime. On the other hand, a country whose domestic financial market is more integrated to the world... You do not currently have access to this content.

How to Improve the Effectiveness of Monetary Policy in the West African Economic and Monetary Union

The West African Economic and Monetary Union (WAEMU) is a currency union with a fixed exchange rate and limited capital mobility and, therefore, an independent monetary policy in the short run. The Central Bank of West African States (BCEAO) is conducting the single monetary policy with the main goal of preserving price stability and supporting economic growth. However, the effectiveness of its monetary policy remains low, with a weak reaction of market interest rates and inflation to BCEAO’s policy actions. The paper concludes that, while the institutional setup and the instruments of monetary policy are adequate, the transmission mechanism of monetary policy remains constrained by liquidity management practices, shallow and segmented financial markets, and interest rate rigidities. To improve the effectiveness of monetary policy the BCEAO should be more proactive in determining the stance of fiscal policies, develop financial markets, and liberalize controlled interest rates. The BCEAO is undertaking important reforms in these directions.

How to Improve the Effectiveness of Monetary Policy in the West African Economic and Monetary Union

The West African Economic and Monetary Union (WAEMU) is a currency union with a fixed exchange rate and limited capital mobility and, therefore, an independent monetary policy in the short run. The Central Bank of West African States (BCEAO) is conducting the single monetary policy with the main goal of preserving price stability and supporting economic growth. However, the effectiveness of its monetary policy remains low, with a weak reaction of market interest rates and inflation to BCEAO’s policy actions. The paper concludes that, while the institutional setup and the instruments of monetary policy are adequate, the transmission mechanism of monetary policy remains constrained by liquidity management practices, shallow and segmented financial markets, and interest rate rigidities. To improve the effectiveness of monetary policy the BCEAO should be more proactive in determining the stance of fiscal policies, develop financial markets, and liberalize controlled interest rates. The BCEAO is undertaking important reforms in these directions.

The policy (in)effectiveness of government spending in a dependent economy

This paper analyses the policy effectiveness of government spending in a two-sector open economy whose output and expenditure is comprised of tradables and non-tradables. This framework reveals that government spending on either tradables or, more normally, on non-tradables widens the external deficit, yet how the real exchange rate behaves depends, in the first instance, on in which sector the public spending occurs. It also shows that, irrespective of where government spending falls, there appears to be no significant short run boost to overall output and hence employment a priori, although empirically actual impact would depend on the elasticities of tradable and non-tradable output with respect to the real exchange rate. Furthermore, fiscal stimulus is shown to be unambiguously ineffective if deemed unsustainable by foreign lenders, or implemented under a fixed exchange rate regime with limited capital mobility.

The Sources of Real Exchange Rate Fluctuations in Sub-Saharan Africa

This paper looks into the sources of real exchange rate fluctuations in Sub-Saharan African (SSA) countries. This issue is investigated in a context of small open economies of SSA using a structural Vector Auto Regression (VAR) approach with limited capital mobility and a weak-banking system in Africa. A structural VAR implies long run restrictions of a small open economy model to identify the shocks. The results suggest that the real exchange rate (RER) variability is mostly driven by real disturbances in both the ”Communaute Financiere Africaine” (CFA) and non-CFA countries at long term forecasting horizons. The findings show evidence that nominal shocks seem to matter more in the non-CFA countries in the short run in explaining RER and price level fluctuations as a result of the diverse fiscal and monetary policies in the non-CFA countries in contrast to the CFA countries.

The Effects of Government Spending Under Limited Capital Mobility

This paper studies the effects of government spending under limited international capital mobility, as featured by most developing countries. While external financing of government debt mitigates the crowding-out effect, it generates real appreciation, which contracts traded output and lowers the fiscal multiplier in the short run. The decline of the multiplier is larger when facing debt-elastic country risk premia. Also, government spending is more expansionary with more home bias in government purchases, more sectoral rigidities, and a less flexible exchange rate. Whether the twin-deficit hypothesis holds depends crucially on the extent to which government deficits are financed externally.

The Effects of Government Spending Under Limited Capital Mobility

This paper studies the effects of government spending under limited international capital mobility, as featured by most developing countries. While external financing of government debt mitigates the crowding-out effect, it generates real appreciation, which contracts traded output and lowers the fiscal multiplier in the short run. The decline of the multiplier is larger when facing debt-elastic country risk premia. Also, government spending is more expansionary with more home bias in government purchases, more sectoral rigidities, and a less flexible exchange rate. Whether the twin-deficit hypothesis holds depends crucially on the extent to which government deficits are financed externally.

Is dynamic general equilibrium a theory of everything?

Should we interpret the contributions of Edward C. Prescott and his collaborators, especially Finn Kydland and Rajnish Mehra, to dynamic general equilibrium as just a mathematical restatement of pre-Keynesian business cycle theory in the language of Arrow and Debreu? This essay advances the contrary view that Prescott has been laying the foundations for a theory of everything in macroeconomics that will stretch well beyond the frictionless environments treated in its early version. A theory of everything is an attempt to explain key empirical observations in nearly every subfield of macroeconomics from a simple, logically coherent conceptual platform with a minimum of institutional detail. After reviewing the current state of Prescott’s agenda, we examine several examples of dynamic equilibrium in economies with constant returns to scale, complete markets, idiosyncratic productivity shocks, and limited capital mobility. These examples suggest that the Solow residual controls the entire path of aggregate output if redefined more broadly to include financial, distributional and institutional variables; that the discount factor used in pricing streams of income will shift autonomously over time in response to endogenous changes in the set of unconstrained asset traders; and that a dynamic general equilibrium model with substantive frictions in financial markets goes some distance towards a joint account of well-known empirical anomalies in growth, business cycles, and asset returns.

The exchange rate system and macroeconomic fluctuations in Sub-Saharan Africa

In this paper, we investigate the sources of macroeconomic fluctuations in Sub-Saharan African (SSA) countries with particular attention to the exchange rate system. We use a structural Vector Autoregression (VAR) model with limited capital mobility and long run restrictions to identify the shocks. Supply and terms of trade shocks tend to dominate output movements in the CFA and non-CFA countries alike. However, terms of trade shocks tend to influence the CFA zone to a greater extent and there seems to be a higher influence of demand shocks on output and the real exchange rates in the non-CFA countries.

Growth and income inequality in South Africa

This paper uses a multi-region endogenous growth model to analyze the competing claims of income growth and income distribution in South Africa. The study makes a case for the use of redistributive taxes to offset limited capital mobility between high and low income regions to promote both greater income growth and greater income equality. Market based capital mobility is limited because low income regions are typically characterized by low levels of both physical and human capital which offer little incentive to outside investors. The model estimates annual cross regional convergence rates at <1% in the absence of specific redistributive policies.

Interpreting Saving-Investment Correlations

Feldstein and Horioka (1980) argued that the cross-sectional correlation of saving and investment provides a test of global capital mobility. We argue that the long-run correlation is determined by the intertemporal budget constraint, limited capital mobility and current account targeting. The short-run correlation reflects limited capital mobility and adjustment to supply and demand shocks. Our empirical analysis shows that the short-run correlation varies across countries and not over time, which suggests that it is a country-specific business cycle fact. The long-run correlation has substantially decreased over time, which suggests that limited capital mobility is partly responsible for its high value in the past.

Monetary versus real exchange rate targets when capital mobility is limited

A country that follows a PPP exchange-rate rule with limited capital mobility will face a trade-off between output and price stability, providing money demand is not extremely sensitive to expectations. This conclusion is thus the same as in the closed economy model of Taylor (1979).

Tariffs and the Distribution of Income: The Importance of Factor Specificity, Substitutability, and Intensity in the Short and Long Run

This paper analyzes the effects of changes in relative commodity prices on the distribution of income among factors of production in the context of two models of a simple, two-good economy. In the first model capital is treated as a specific factor in each industry, with labor mobile between industries. The assumption of specificity determines the direction of factor income changes, with magnitudes depending on substitutability between factors and on intensities of factor use within the two industries. In the second model, capital is viewed as a quasi-fixed factor. For the short run, this model is identical to the model first considered. For the long run, this model is identical to the Stolper-Samuelson model in which the direction and magnitude of factor income changes depend solely on relative factor intensities. The difference between the short-run and long-run determinants of changes in factor incomes gives rise to a conflict between factor owners' short-run and long-run interests.