Capital Account Openness Research Articles

Determinants and international transmission of interest rates: Do foreign reserves and sovereign debt matter?

AbstractWe analyze the role of international reserves and sovereign debt in the determination and international transmission of interest rates. We develop a model that describes the money market equilibrium with capital account openness. It predicts that higher levels of international reserves lead to lower interest rates whereas the effect of higher government debt is ambiguous. We then test empirically these predictions on a panel of 128 countries over 1985–2019. We find that: (i) the transmission of U.S. interest rates to domestic interest rates is stronger in emerging market economies (EMEs) than in advanced economies (AEs) for short‐term interest rates (STIR), and vice versa for long‐term interest rates (LTIR); (ii) international reserves help counteract the transmission of the U.S. policy rate on STIR in EMEs; (iii) a higher sovereign debt level is associated with lower interest rates in EMEs (liquidity effect), but higher interest rates in developing economies (risk premium effect).

The Impact of China’s Capital Account Liberalization on the Direction of Cross-border Capital Flows

Objective: This article aims to investigate the impact of China’s capital account openness (OPEN) on cross-border capital flows (CCF). Methods: The research utilizes the ARDL-ECM model for empirical analysis. It begins by summarizing existing literature on the topic and then proceeds to analyze the data spanning from 1998 to 2023. The study explores the long-term cointegration relationship between OPEN and CCF. Additionally, it investigates the correlation between the direction of openness and its effect on CCF. Notably, the research introduces the concept of the volatility of OPEN as an explanatory variable to understand its impact on various types of capital flows. Results: The findings reveal a significant long-term cointegration relationship between OPEN and CCF. This relationship is significantly influenced by the direction of openness. Moreover, the study identifies that the volatility of OPEN notably affects different categories of capital flows. Furthermore, it observes that structural changes in net foreign securities investment are comparatively higher than those in net foreign direct investment. Conclusion: This study underscores several recommendations for the ongoing process of capital account liberalization in China. Firstly, adjust OPEN flexibly to promote or restrict specific types of capital flows. Adopt elastic capital control measures for different types of capital flows to balance the stability of domestic capital markets and the activity of international capital flows. Secondly, careful adjust capital outflow openness to maintain economic environmental stability and prevent capital flight. Lastly, encourage long-term investment, particularly in the real economy and infrastructure sectors, and provide incentives for investors committed to long-term investment.

Bilateral Remittance Inflows to Asia and the Pacific: Countercyclicality and Motivations to Remit

This paper examines the cyclicality of remittance inflows to economies in Asia and the Pacific, aiming to identify major factors associated with remittances using gravity models of bilateral remittances. An analysis that assesses correlation coefficients between the cyclical factors of remittances and gross domestic product suggests that remittances tend to be countercyclical, or acyclical, against the business cycle of the remittance-receiving economy relative to the sending economy. This observation is confirmed by the gravity models of bilateral remittances. Furthermore, the estimation results suggest that migrant stock is one of the most significant factors affecting bilateral remittances. The study also shows that an increase in bilateral remittances can be attributed to a higher occurrence of disasters triggered by natural hazards in receiving economies, an appreciation of the receiving economy’s currency value against the sending economy’s, a lower interest rate differential (receiver–sender), greater capital account openness, more political instability, and lower costs of remittances.

Are financial sanctions truly “smart”? Evidence from the perspective of cross‐border capital flows

AbstractFew studies are found to examine the impact of financial sanctions on cross‐border capital flows. Using a panel data from 48 countries from 2000 to 2019, this paper aims to examine the impact of financial sanctions on the volatility of cross‐border capital flows. We employ difference‐in‐differences (DID) and spatial DID (SDID) models, showing the result that financial sanctions lead to an exacerbation of the volatility of cross‐border capital inflows and outflows in the targeted country, with the channel of negative impact on the financial sector in the targeted country. The subsample regressions indicate heterogeneous impacts of financial sanctions depending on economic structure and capital account openness. Additionally, the result of the SDID model shows that financial sanctions cause cross‐border transmission of financial risks, and that the spatial spillover effect of financial sanctions will also have negative economic impacts on other countries in addition to the target country. The significance of this study lies in emphasizing that international financial sanctions affect the economy of target countries through cross‐border capital flows. Meanwhile, we confirm that financial sanctions pose a certain threat to global financial stability.

Interest rates across the world: Global, regional, and idiosyncratic factors

This paper employs a dynamic factor model with endogenous regional clustering and extreme value adjustment properties to construct a world interest rate, as well as regional factors, based on country-specific short-run real interest rates from 43 markets. We find that global and regional factors play crucial roles in determining local rates among advanced countries, while local factors are more important among emerging markets. Further, convenience yields essentially affect both global and regional rates, especially in the longer run. Moreover, the relationship between global and local rates depends crucially on capital account openness, while the choice of exchange rate regime is a critical determinant of the transmission of regional factors. Lastly, we show that a U.S. nominal rate shock would raise the global real rate a quarter later, with a stronger impact observed before the U.S. rate hits the zero lower bound in 2008.

The impact of capital Inflow's features on the effectiveness of capital controls - Evidence from multinational data

This paper explores how features of capital inflow affect the effectiveness of capital controls from three aspects: capital types, inflow intensity, and channels diversity. Empirical results by using multinational data show that capital controls are more effective in an economy with lower degree of capital account openness, when there are more short-term capital inflows and in an intense inflows period. This study is helpful to explain the inconsistency of conclusions about the effectiveness of capital controls in existing studies, and has certain policy implications to curb excessive capital flows for governments.

The Role of Macro‐Economic Policy in Explaining China's Current Account Surplus

AbstractI assess how much of China's current account surplus can be explained by government policy of capital controls and foreign reserve accumulation during a period of rapid productivity growth. My model can generate an increase in China's current account surplus and foreign reserve holdings. I find that half of the peak in China's current account surplus can be explained by its capital control policies and half by its foreign reserve accumulation policies. Under an open capital account and floating exchange rate, China would have run a current account deficit of 6.5% of GDP.

Capital Account Openness as a Signal: Does Capital Mobility Improve Fiscal Discipline?

Capital Account Openness as a Signal: Does Capital Mobility Improve Fiscal Discipline?

Chinese monetary policy spillovers on its international portfolio investment flows

This paper examines Chinese monetary policy spillovers on its international portfolio investment flows with a factor-augmented vector autoregression (FAVAR) model. The paper extracts a FPI factor from certain time series to measure monthly foreign portfolio investment flows (FPI). Four Chinese monetary policies are considered: central-bank target policy rate; required reserve ratio; M2; banks' loans. The robust and significant results show that interest rates and banks' loans have significant impact on Chinese international portfolio investment flows, while changes in reserve requirements are not effective. It reveals the increasingly important effects of Chinese monetary policies on its cross-border portfolio investment flows following decades' capital account openness and the reform of interest rate liberalization in China, which indicates that Chinese monetary policy is approaching to a market-based framework.

Consecutive decentralization: The effect of central bank independence on capital account liberalization

AbstractCentral bank independence (CBI) has been widely advocated as a means to address the time‐inconsistency problem of controlling inflation. Consequently, many countries have embraced central bank reforms since the 1990s. While extant research in political science has sought to unveil the consequences of CBI, there remains an unexplained variation in the response of countries with regard to capital account openness. Notably, a positive association exists between CBI and capital account openness due to the constraints CBI places on leaders' discretionary monetary and fiscal policies, thereby fostering reliance on financial policy to boost their economies. However, this relationship is contingent on the domestic political contexts of countries. CBI leads to capital account liberalization only when the rule of law is guaranteed, given that CBI is often stipulated by laws. Therefore, in countries where political leaders can easily override formal rules, CBI shows no discernible impact on capital account openness. Employing two‐way fixed‐effects and error‐correction models, the study reveals that CBI increases capital account openness only in democracies, in the presence of multiple veto players, and a high level of transparency. The findings underscore the pivotal role of the domestic political environment in analyzing how CBI constrains political leaders.

South Africa’s interest rate behaviour: Investigating the influence of the indicators of financial openness

This study seeks to investigate the influence of financial openness variables on South Africa’s interest rate during the period between1980-2020. The study used both Augmented Dickey-Fuller (ADF) and Philip-Perron (PP) tests to determine the order of integration of the variables, while the autoregressive distributed lag (ARDL) bounds test was used to investigate both the short and long-run impact of the independent variables on the dependent variable. The findings of the study revealed that in the short-run both foreign direct investment (FDI) inflows and FDI outflows impacted the interest rate positively. However, portfolio investment, exchange rate and capital account openness did not have any significant impact on interest rate within the duration of this research. The long-run results revealed that FDI inflows had a positive and significant impact on interest rate. Also, while capital account openness had a significant and positive impact on the interest rate, FDI outflows, portfolio investment, and the exchange rate had no significant impact on interest rate. The study concludes that apart from portfolio investment which did not exert significant impact on interest rate, other financial openness indicators used in the study had a significant impact on South Africa’s domestic interest rate. The paper argues that, appropriate monetary policy measures targeted to lessen the monetary impact of excess capital inflows should be considered. Additionally, capital account liberalization policy should be encouraged, but it needs to be regulated if it places an excessive amount of liquidity pressure on the economy.

The impact of China’s bilateral currency swap agreements on bilateral direct investments

ABSTRACT This paper investigates the impact of China’s bilateral currency swap agreements (BSAs) on bilateral direct investments (BDIs). We treat signing China’s BSAs as a quasi-natural experiment and employ the gravity model with a staggered difference-in-differences (DID) method to explore the relationship between signing China’s BSAs and BDIs. Our empirical results suggest that signing China’s BSAs and increasing their value can effectively boost BDIs. The findings remain robust after utilizing the propensity score matching DID (PSM-DID) method, the instrumental variable method, adding additional explanatory variables, and eliminating interference from critical events. In addition, we find that the impact of China’s BSAs on BDIs varies significantly depending on partner country features, such as level of development, whether to sign the Belt and Road Initiative (BRI), trade relations with China, and the degree of capital account openness. Moreover, the governance quality in the host country has a positive moderating effect on the impact of China’s BSAs on the country’s FDI. Our study has vital policy implications for governments worldwide that have signed China’s BSAs and those that want to promote BDIs by signing China’s BSAs.

Banking concentration, financial openness, and financial development

AbstractWe examine how financial development in the banking sector depends on the degree of capital account openness and the degree of bank concentration across countries. Using data on 136 countries, we find that the relationship of openness to credit market activity depends on the level of economic development. In high income countries, openness is only associated with higher credit market activity in concentrated banking systems. However, in developing countries, there is evidence that openness is associated with higher credit market activity regardless of concentration. Moreover, in contrast to previous work we examine how the impact of concentration depends on openness.

How Do Short-Term Cross-Border Capital Flows Affect Bank Risk-Taking? Evidence from China

ABSTRACT This study examines the impact of short-term cross-border capital flows on banks’ risk-taking using panel quarterly data from all 37 A-share listed commercial banks in China. We demonstrate that short-term cross-border capital flows increase both ex ante and ex post risk-taking by banks. The impact of short-term cross-border capital flows upon banks’ ex ante and ex post risk-taking is heterogeneous across different kinds of commercial banks and at different phases of the financial cycle. Besides, short-term cross-border capital flows exhibit a non-linear effect on banks’ ex ante risk-taking and ex post risk-taking with changes in capital account openness.

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Purpose: This research aims to investigate the presence of monetary policy trilemma in the Middle Eastern region and evaluate the spillover effects of US monetary policy on the region. Theoretical framework: Middle Eastern economies follow the dollar pegged exchange rate policy with open capital account and this poses a question about the autonomy of the monetary policy stance adopted by the regional central banks. In this context, current research considers variables such as domestic interbank interest rate, domestic liquidity, oil price and federal fund rate to test the monetary policy trilemma in the region Design/methodology/approach: To investigate the presence of monetary policy trilemma in the Middle Eastern region, this research employs the time - varying Bayesian panel vector autoregression approach and selects a panel of five Middle Eastern countries which include Saudi Arabia, United Arab Emirates, Qatar, Oman and Kuwait while considering the monthly data for the sample period 2009m10 until 2021m12. Findings: This research finds that a positive shock in US federal fund rate increases the domestic interest rates in the Middle Eastern economies. In addition, this research finds a negative relationship between oil price shocks and domestic interest rates. Whereas a positive shock in US federal fund rates induces a reduction in the oil price. Research, Practical & Social implications: Current research provides insights for policy makers to determine the autonomy of domestic monetary policy stance to achieve its broader macroeconomic objectives. . Originality/value:This research is unique as it examines the monetary policy trilemma while considering oil price as a control variable in the system under a time varying Bayesian panel vector autoregression specification.

Testing Monetary Policy Trilemma for Middle Eastern Economies Under a Bayesian Panel VAR Specification

Purpose: This research aims to investigate the presence of monetary policy trilemma in the Middle Eastern region and evaluate the spillover effects of US monetary policy on the region.
 
 Theoretical framework: Middle Eastern economies follow the dollar pegged exchange rate policy with open capital account and this poses a question about the autonomy of the monetary policy stance adopted by the regional central banks. In this context, current research considers variables such as domestic interbank interest rate, domestic liquidity, oil price and federal fund rate to test the monetary policy trilemma in the region
 
 Design/methodology/approach: To investigate the presence of monetary policy trilemma in the Middle Eastern region, this research employs the time - varying Bayesian panel vector autoregression approach and selects a panel of five Middle Eastern countries which include Saudi Arabia, United Arab Emirates, Qatar, Oman and Kuwait while considering the monthly data for the sample period 2009m10 until 2021m12.
 
 Findings: This research finds that a positive shock in US federal fund rate increases the domestic interest rates in the Middle Eastern economies. In addition, this research finds a negative relationship between oil price shocks and domestic interest rates. Whereas a positive shock in US federal fund rates induces a reduction in the oil price.
 
 Research, Practical & Social implications: Current research provides insights for policy makers to determine the autonomy of domestic monetary policy stance to achieve its broader macroeconomic objectives.
 
 Originality/value: This research is unique as it examines the monetary policy trilemma while considering oil price as a control variable in the system under a time varying Bayesian panel vector autoregression specification.

Growth trajectories and political economy in a Structuralist open economy model

This paper presents a set of growth and distribution models for open developing economies under different political economy regimes. These regimes give rise to different institutional frameworks which in turn shape macroeconomic outcomes. We focus on three cases: (1) a pure developmentalist state, (2) conflicting claims between workers and government, and (3) an open capital account under a Neoliberal coalition. The equilibrium growth rate is defined by the Balance-of-Payments (BOP) constraint. Cumulative causation à la Kaldor in periods in which the depreciation of the real exchange rate temporarily raises the equilibrium growth rate allows (under certain conditions) for a process of learning that transforms the income elasticity of exports and hence the BOP-constrained rate of growth in the long run. The model produces a variety of outcomes that explains some of the contradictory results reported in the empirical literature in terms of different constellations of power and institutions.

Catching up by ‘Deglobalizing’: Capital account policy and economic growth

While substantial empirical research has evaluated the question of whether capital account openness promotes economic growth, this paper finds empirical evidence for cases where the opposite is true—that a policy of capital controls can promote economic growth, when combined with a policy of reserve accumulation. Using panel data from 45 countries from 1985 to 2019, we find that capital controls combined with reserve accumulation—strategic capital account policy—contribute to growth in real GDP and TFP. This effect is stronger for emerging markets and prior to the global financial crisis. We show that the policy is strongly associated with enlarging the scale of the manufacturing sector and productivity, and is consistent with theories of learning-by-doing through exporting.

The Impact of Capital Account Opening on RMB Internationalization

At this stage, the internationalization of RMB is inseparable from the opening of capital account, and in this process, it is bound to face the challenge of systemic financial risks. Based on SV-TVP-VAR model, this paper makes a time variant analysis on the systemic financial transmission mechanism of capital account opening Affecting RMB internationalization. It is found that the opening of capital account promotes the development of RMB internationalization, and the international use of RMB will force the expansion of capital account opening. Further research shows that the current capital account is not easy to fully open, capital account convertibility intensifies the spillover of macroeconomic risks and external market risks, and macro prudential supervision needs to be improved. The restraint of capital account opening on monetary liquidity risk and asset bubble risk shows time varying characteristics, and the long-term development of RMB internationalization urgently needs to deepen the reform of financial system.

Examining the Impact of Financial Openness on Domestic Interest Rate in Nigeria

The sensitive role played by domestic interest rate in the economy has made studies on its determinants paramount. This study therefore used the autoregressive distributed lag (ARDL) bounds framework to investigate the impact of financial openness on domestic interest rate in Nigeria over the period from 1980–2020. The study included three de facto financial openness measures, namely: foreign direct investment (FDI) inflows, FDI outflows and portfolio investment as well as one de jure financial openness measure, namely: capital account openness. The short-run results revealed that while FDI inflows had a negative but non-significant impact on domestic interest rate, the impact of FDI outflows was positive and significant. The short-run results also indicated that while foreign portfolio investment had a positive but non-significant impact on domestic interest rate, the impact of capital account openness was positive and significant. In the long-run, the study revealed that FDI inflows had a negative but non-significant impact on domestic interest rate. In another vein, while FDI outflows was found to impact on domestic interest rate positively, the impact of capital account openness was also found to be positive. The study therefore concludes that domestic interest rate in Nigeria was influenced positively by both FDI outflows and capital account openness in the two time horizons and this has implications for monetary policy setting. Based on these findings, the study recommends that apart from the traditional policies used in the control of domestic interest rate, monetary authorities in Nigeria should also regulate capital outflows in their quest to direct interest rate to a desired direction.