Surge In Capital Inflows Research Articles

Gross capital inflows, the U.S. economy, and the response of the Federal Reserve

In recent years, there has been a surge in capital inflows to the United States' treasury and corporate bond markets from other countries. How do these inflows affect economic activity in the United States? Does the Federal Reserve respond to such shocks? To address these important issues, we employ a sign-identified structural vector autoregressive (SVAR) model to see the effects of these types of capital inflows. Our results suggest that the U.S. economy and the Federal Reserve's balance sheet respond differently to shocks to these inflows. In particular, gross inflows to U.S. treasuries are contractionary while inflows to corporate debt are expansionary. Moreover, the Federal Reserve shrinks its balance sheet in response to shocks to gross capital inflows to U.S. treasury securities with little to no response to inflows to corporate securities. Interestingly, we find that the bulk of the Fed's response to both shocks is systematic. In this manner, the Federal Reserve's response to these shocks played only a minor role in the evolution of macroeconomic aggregates following such shocks.

Capital flows and income inequality

We document empirical evidence that surges in capital inflows (outflows) raise (reduce) income inequality. We study the mechanism through which changes in capital flows and capital account policies can influence income distributions in a small open economy model. Our model features heterogeneous agents and financial frictions, with banks intermediating between household savings and entrepreneur investment. Inflow surges disproportionately raise entrepreneur income, exacerbating inequality, while increases in outflows boost the share of household income, alleviating inequality. Under capital-skill complementarity, capital account liberalization that induces net capital inflows raises both the skill wage premium and overall income inequality. These predictions are in line with our empirical evidence.

Managing Foreign Exchange Inflows: An Analysis of Sterilisation in Pakistan

A number of developing countries from Asia, Latin America and Eastern Europe have experienced surge in capital inflows during recent years.1 These inflows have potential effects on macroeconomic stability; export competitiveness, and inflation. If not properly managed, these inflows can induce appreciation of local currency leading to serious repercussions for the rest of the economy. Under these conditions, the proactive role of monetary authorities in the management of capital inflows was highly desirable, wherein they intervened in the domestic exchange market in order to contain volatility in exchange rate besides accumulation of foreign exchange reserves. The main instruments available to deal with the possible effects of large capital inflows include sterilised intervention, fiscal tightening, trade and exchange liberalisation including easing controls on capital outflows. The foreign exchange interventions are typically accompanied by active sterilisation policy to keep inflation under control.

Capital Inflows, Inflation, and the Exchange Rate Volatility: An Investigation for Linear and Nonlinear Causal Linkages

This paper empirically examines the effect of foreign capital inflows on domestic price levels, monetary expansion, and the exchange rate volatility for Pakistan using linear and nonlinear causality tests. The key message emerging from the analysis is that there is a significant inflationary impact of capital inflows, in particular during the period of surges in capital inflows. Specifically, we find evidence of a significant nonlinear Granger causality running from capital inflows to the change in domestic prices. We also show that domestic prices are nonlinearly caused (in Granger sense) by the growth of domestic debt and money supply-to-GDP ratio. Our results, however, suggest that the market interest rate and the nominal exchange rate do not have significant relationships with domestic prices. The findings suggest that there is a need to manage the capital inflows in such a way that they should neither create an inflationary pressure in the economy nor fuel the exchange rate volatility. JEL Classification: C22, C32, F21, F31, F32 Keywords: Capital Inflows, Inflationary Pressures, the Exchange Rate Volatility, Monetary Expansion, Nonlinear Dynamics

Capital flows to low-income sub-Saharan Africa: an exploratory review

PurposeThe purpose of the paper is to examine macroeconomic and institutional factors that influence capital flows to low-income sub-Saharan African (SSAn) countries. It analyzes capital flows in a disaggregated manner: foreign divert investment, portfolio equity and portfolio debt. There is a gap in the empirical literature in examining the factors that are important for various types of capital flows to low-income SSAn countries. Low-income SSAn countries attract very low levels of foreign investment compared to other developing economies in the SSAn region and other developing economies and this paper attempts to make a contribution in this area.Design/methodology/approachThis paper examines data on capital flows and that of various push and pull factors. Trends and dynamics of capital inflows and their macroeconomic and institutional drivers are analyzed for low-income sub-Saharan African countries. Such an analysis has not been fully explored for low-income SSAn countries.FindingsCapital inflows to low-income sub-Saharan Africa (SSA) have increased sevenfold since the 1990s, dominated by foreign direct investment (FDI). They overtook official development assistance and aid in the 2010s. Mozambique and Ethiopia attract the largest size of FDI compared to other low-income SSAn economies, with natural resources as key factors in the former. The largest share of FDI to low-income SSAn countries comes from other SSAn countries, mostly South Africa and Mauritius. Among macroeconomic push factors, capital inflows are more closely related to commodity prices, while the volatility index and global liquidity are also important. Among macroeconomic pull factors, trade openness and economic growth appear more closely related to capital inflows. The surge in capital inflows in the 2000s also followed the implementation of several regional trade and investment agreements in the region. The improvement in internal conflict in the 1990s and mid-2000s seems to have helped support the increase in capital inflows during that period. This institutional quality variable appears to more closely track capital inflows compared to other institutional quality indicators. There were also improvements in the investment profile, law and order, and government stability in the 1990s to early 2000s when capital inflows picked up.Research limitations/implicationsThis study focuses on low-income SSAn countries, which are less studied in the empirical literature and that face immense developmental needs that require foreign and domestic capital.Practical implicationsFindings of this paper can shed light to policy makers on the factors that are most important to help the region attract capital inflows and areas where further improvement is needed in the macroeconomic and institutional environment.Originality/valueThere is a gap in the empirical literature in examining the factors that are important for attracting capital flows to low-income SSAn countries. To our knowledge, this study may be the first to explore dynamics of capital flows against institional quality for low-income SSAn countries at a disaggregated level.

Financialized Growth and the Structural Power of Finance: Turkey's Debt-Led Growth Regime and Policy Response after the Crisis

This article analyzes the Turkish central bank's “managed uncertainty” policy after the global financial crisis. During 2010–14, the central bank intentionally generated uncertainty around short-term interest rates, using the level of predictability faced by financiers as a tool to buffer the domestic economy from volatile capital flows. How did the central bank implement this unconventional policy? Building on interview data and public texts, the article argues that the surge in capital inflows after the crisis sourced a debt-led, financialized economic growth model and deepened Turkey's reliance on external financing. The central bank could diverge from the financial sector's policy preferences despite Turkey's increased foreign capital dependence because the availability of low-cost, ample, private funding opportunities temporarily expanded policymakers’ room to maneuver. However, operating vis-à-vis an unsustainable growth regime, the central bank had to revert to orthodoxy in 2014 due to declining investor confidence and capital flight. This article contributes to the literature on the structural power of finance by demonstrating how finance derives its structural power from funding financialized growth, not productive investments. It also shows that financial structural power varies based on the source and cost of external financing beyond the degree of foreign capital dependence.

A Dutch disease approach into the premature deindustrialization

We explore the main causes and consequences of the premature deindustrialization phenomena. We argue that local currency overvaluations mainly associated with a surge in capital inflows into the emerging market economies following the deregulation of their capital accounts severely hurt the output share of manufacturing industry. Applying the second generation estimators allowing for cross-section dependency (Augmented Mean Group and Common Correlated Effects Mean Group), we run a panel data regression model based on a sample of 39 developing countries in Latin America, Sub-Saharan Africa, East Asia, North America, and Europe from 1960 to 2017. We show that the baseline regression results are robust to different data sets, alternative real exchange rate/deindustrialization measurements, and dynamic model specifications. We find that an overvaluation of 50% which corresponds approximately to one and half standard deviations is associated with a contraction of manufacturing output share as high as 1,25% over the five year period. Moreover, the evidence suggests that the manufacturing competencies which have been eroded by local currency overvaluations in real terms cannot simply be brought back during the undervaluation periods. Hence, the need for a comprehensive industrial policy along with a firm use of capital controls and macroprudential measures given a robust institutional framework comes out as the main policy implication of our results, and they are duly discussed in light of recent developments in the literature.

Are capital inflow bonanzas a common precursor to banking crises? A categorical data analysis

AbstractThe empirical literature that relates capital inflow bonanzas to the risk of a banking crisis has, so far, examined the probability of a crisis conditional on a bonanza episode. We argue that estimating the probability of a prior capital inflow bonanza, given the occurrence of a banking crisis, is at least equally important from a policy perspective to limit the exposure to sudden, big surges in capital inflows and reduce the risk of a systemic banking crisis. We consider two global samples, one consisting of 64 countries for 1970–2008 and the other 111 countries for 1980–2008. In both samples, we show that the latter conditional probability is strikingly large, much higher than the former, and even higher if we consider only "systemic" banking crises in developing countries. We also construct 2 × 2 contingency tables, utilise the odds ratio and conduct statistical tests to show that the association between bonanzas and crises is significant and robust across the two samples. The association is much stronger than commonly understood, most notably for systemic crises in developing countries. The findings provide support for stronger policies to limit or dampen unusual surges in international capital flows.

A Managed Policy on Capital Inflows

Cross-border capital flows create dilemmas and trade-offs for monetary policy due to their many benefits, like financing economic growth and consumption of households, and their potential adverse macroeconomic effects, which can be caused by real appreciation of a recipient country’s currency and a large stock of debt that can cause difficulty in servicing. We examine conditions under which a country will restrict capital inflows to mitigate their adverse macroeconomic effects. Our game-theoretic modelling captures a dynamic interaction between policy and investment. Using the subgame perfect Nash equilibrium concept, we show that the government restricts capital inflows if the local economic conditions are strong enough to discourage a surge in capital inflows but relaxes the restriction if the economic conditions in the investors’ home are strong enough to attract capital inflows. The restriction has large impact on short-term capital inflows and is effective in channelling capital inflows into long-term investments.

Unintended Consequences of U. S. Monetary Policy Shocks: Dutch Disease and Capital Flow Measures in Emerging Markets and Developing Economies

Dutch disease is often referred as a situation in which large and sustained foreign currency inflows lead to a contraction of the tradable sector by giving rise to a real appreciation of the home currency. This paper documents that this syndrome has been witnessed by many emerging markets and developing economies (EMDEs) as a result of surges in capital inflows driven by accommodative U. S. monetary policy. In a sample of 25 EMDEs from 2000-17, U. S. monetary policy shocks coincided with episodes of currency appreciation and a contraction in tradable output in these economies. The paper also shows empirically that the use of capital flow measures (CFMs) has been a common policy response in several EMDEs to U.S. monetary policy shocks. Against this background, the paper presents a two sector small open economy augmented with a learning-by-doing (LBD) mechanism in the tradable sector to rationalize these empirical findings. A welfare analysis provides a rationale for the use of CFMs as a second-best policy when agents do not internalize the LBD externality of costly resource misallocation as a result of greater capital inflows. However, the adequate calibration of CFMs and the quantification of the LBD externality represent important implementation challenges.

Monetary policy, hot money and housing price growth across Chinese cities

ABSTRACT We use a dynamic hierarchical factor model to identify the national, regional and local factors of the city-level housing price growth in China. During the zero-lower-bound (ZLB) episode in the U.S., local factors account for 78% of variations in the month-on-month city-level housing price growth. However, as the time horizon extends, the national factor gets a larger variance share, reaching 51% in a half-year horizon. This indicates that the city-level housing price growth in China is more of a national phenomenon in the long run. We then use a VAR model to investigate the driving forces of the national factor and find that monetary policy and hot money shocks affect the national housing price growth significantly. A tightening monetary policy shock has a significant negative impact on the national factor, which lasts for more than 2 years. An increase in hot money inflows causes a significant but transitory rise in the national factor. Moreover, we find that the quantitative easing measure adopted by the U.S. Fed is behind the surge of capital inflows into China.

INVESTIGATING THE EFFECTIVENESS OF STERILIZATION POLICY IN CONTROLLING MONEY SUPPLY AND CAPITAL INFLOWS IN NIGERIA

Over the last decade, Nigeria has witnessed rising capital inflows that have kept the monetary authorities on their toes. This study, therefore, investigated the effectiveness of sterilization policy in controlling money supply and capital inflows in Nigeria. The need for this investigation arose from observed dearth of study in this area in Nigeria as well as the surge in capital inflows within the study period with its likely macroeconomic implications. The study would answer the question: (1) to what extent does sterilization effort of the Central Bank of Nigeria effective in controlling capital inflows in Nigeria, (2) to what extent is sterilization policy able to regulate money supply in Nigeria. By utilizing monthly data spanning a period of 2010-2018 under the framework of Two Stage Least Squares (2SLS), findings show that the sterilization policy of the CBN is effective in regulating money supply and depressing capital inflows both in period of normal capital inflows and in period of intensive capital inflows. We therefore recommend that in periods of sudden and volatile capital inflows, sterilization measure should be given a priority in order to stave off the negative consequences of such unexpected inflows. We also recommend fiscal prudency on the part of the fiscal authorities, especially within the period of high and volatile capital inflows just as the observance of a synergy between fiscal and monetary policies is not ruled out.

Do macroprudential policies counter real exchange rate appreciation in emerging markets?

AbstractA competitive and stable real exchange rate (RER) has been recognised as an important variable for promoting economic development, especially in emerging and developing economies (EMDEs). The postglobal financial crisis era, however, has seen a marked deluge of global liquidity from ultra‐loose monetary policy in advanced economies, which has led to a surge in capital inflows and consequent loss of external competitiveness in several EMDEs. Given this context, this paper empirically investigates if and what types of macroprudential policies (MaPs) have been effective in countering RER appreciations in a panel of 93 EMDEs over the period 2000–2013. Our results show strong evidence that MaPs moderate RER appreciation through the real interest rate channel, though this is limited to MaPs that target financial institutions rather than borrowers. There is also evidence to suggest that MaPs work more effectively during periods of rising rather than falling real interest rates.

Capital Controls and Income Inequality

We document empirical evidence that surges in capital inflows (outflows) raise (reduce) income inequality. We then introduce a small open economy model that explains these observed links between capital flows and income distribution. Our model features heterogeneous agents and financial frictions, with banks intermediating between household savings and entrepreneur investment. Capital flows influence income distribution through movements in both capital income and labor income: Inflow surges disproportionately raise returns to entrepreneur investment, while outflow surges boost returns to household savings. Under capital-skill complementarity, capital inflows also increase inequality by raising the skill wage premium.

Capital Inflow Surges and Corporate Debt Maturity Structure

Capital inflow surges destabilize the economy through a maturity shortening mechanism. The underlying reason is that firms tend to make their debt redeemable on demand in order to accommodate the potential liquidity needs of global investors, which makes international borrowing endogenously fragile. Based on a theoretical model and empirical evidence at both firm level and macro level, our main findings are threefold. First, corporate debt maturity shortens substantially during surges, especially for firms with foreign bank relationships. Second, surges change the shape of the interest rate term structure and lead to a more flattened yield curve. Third, the probability of a crisis following surges with a flattened yield curve is significantly larger than following surges without one. Our work suggests that debt maturity is key to understanding the consequences of capital inflow bonanzas.

Capital Mobility in India : Does Sterilization Matter ?

This paper examined a linkage between capital flows, floating but managed exchange rate, and conduct of monetary policy in India. The sporadic surge in capital inflows have caused a great deal of fluctuations on the domestic exchange rate. Considering this, we analyzed different channels through which the RBI intervened in the foreign exchange market to provide greater leeway in conduct of the monetary policy. The study found that after the global financial crisis, RBI has proactively been engaged into selling of foreign currency concurrently with buying of dollars in the forex market so that the Indian rupee can be stabilized, and currency volatility can be diminished. However, prior to the crisis in the aftermath of unprecedented capital inflows, foreign reserves were accumulated to stabilize the exchange rate. We investigated the extent of sterilization of capital inflows by deploying a sample of quarterly data over the period from 2002 - 2015 and found that reserve money was sterilized to a significantly higher degree during the pre-crisis period (2002-2007) than the post-crisis period (2008-2015). The impact of direct intervention by the central bank was found largely effective in the post-crisis period. Further, this study highlighted various challenges emanating from sterilization to the economy in terms of burden of interest payment on the government securities and less availability of funds as needed for developmental expenditures. Full sterilization of reserve money may reduce exchange rate volatility and can provide much control over domestic monetary conditions; however, the risks of financial instability remain present.

Ride the Wild Surf: An investigation of the drivers of surges in capital inflows

Industrial countries and emerging markets economies (EMEs) have experienced a wild ride on gross capital inflows over the past 15 years. After reaching a record high in the run-up to the global financial crisis, they collapsed dramatically in 2008–9. As the world economy started to recover, global capital flows resumed at different speeds. Capital flows into EMEs recovered faster than those flows in industrial economies. This paper aims at understanding the drivers of these surges in gross inflows using quarterly data for 79 countries from 1975 to 2014. We find that domestic and external drivers have a significant explanatory power in driving surges of inflows. Domestic factors appear to play a significantly larger role in explaining surges into EMEs. Zooming in our findings shows that: (a) overvalued currencies rather than credit growth tend to attract massive capital inflows, (b) surges to either industrial countries or EMEs are driven by regional contagion, (c) strong growth and natural resource abundance are key to attract inflows of foreign capital into EMEs, (d) lower policy uncertainty about the global economy tend to trigger surge episodes, and (e) an increase in global risk aversion would precede the end of surges.

Modelling portfolio capital flows in a global framework: Multilateral implications of capital controls

In the aftermath of the global financial crisis, many emerging market countries resorted to capital controls to tackle the excessive surge of capital inflows. A number of recent research papers have suggested that the imposition of controls may have imposed negative externalities on other countries by deflecting flows. Our aim in the research reported in this paper is to assess the efficacy of capital controls and potential deflection effects on other countries by constructing a comprehensive global econometric model which captures the dynamic interactions of capital flows with domestic and global fundamentals. The results suggest that capital controls are effective for some countries in the short run, but have no lasting effects. Moreover, there is only limited evidence of deflection effects for a small number of emerging market countries.

Does international capital flow lead to a housing boom? A time-varying evidence from China

ABSTRACTThis paper examines the causal relationship between the housing prices (HP) and the international capital flows (ICF) in China. With structural changes existing, we find that long-run relationship using full-sample data is unstable, suggesting that traditional Granger causality test is not reliable. However, we further find an unstable short-run relationship between ICF and HP when assessing the stability of the parameters and there are bidirectional causal relationships between ICF and HP for several sub-periods. Additionally, our findings indicate both positive and negative bidirectional causal relations between the series. Based on the arbitrage of ICF, the results suggest that the rise of Chinese HP is the underlying force for the inflows of international capital. Meanwhile, a surge in capital inflows may be accompanied by a rise in the price of housing. This confirms the theoretical analysis that there is an interconnected transmission mechanism between the ICF and the HP, which is diverse and depends both on the flow of ICF and on other factors.

Investment and bank credit recovery after banking crises

In this paper, we aim to investigate (a) the dynamic adjustment of investment-to-GDP ratio and bank credit-to-GDP ratio following banking crisis episodes; (b) whether the adjustment of investment and bank credit ratios varies with several country and crisis characteristics. Based on a sample of 79 developed and emerging countries over the 1973–2010 period, our results suggest that in the aftermath of banking crises, investment ratio declines but swiftly recovers to its pre-crisis level within two to three years. Bank credit declines significantly and remains stagnated even in the medium run. In terms of country characteristics, we find that investment and bank credit ratios decline significantly more in advanced countries and countries with higher level of capital openness. In addition, investment ratio declines significantly more in countries with higher level of financial development. Finally, we split the banking crises episodes into two categories: those preceded by a domestic credit boom or a surge in net capital inflows, and those that were not preceded by such booms. We find that dynamic adjustment of investment and bank credit ratios differs substantially across the two groups. Existence of a credit boom or a surge in capital inflow in the run-up to the crisis intensifies the length and depth of the decline in investment and bank credit ratios. In fact, we find no statistically significant decline in investment following banking crises that were not preceded by a credit boom or a surge in capital inflows. These results imply that deleveraging is costly to the economy.