Surge In Capital Inflows Research Articles

Capital Surges and Credit Booms: How Tight is the Relationship?

It has been frequently argued that surges in capital inflows are a major cause of credit booms and banking crises in emerging market economies. This view suggests that there is little role that can be played by domestic policy to break this linkage. This need not be the case. We show that the linkage between surges and booms is not as strong as is often assumed. One problem with most previous studies is that a wide range of measures for both surges and booms has been used with little checking of the robustness of results. We deal with this issue by replicating 14 different measures of capital surges (gross and net) and 5 credit boom proxies from the literature on a sample of 46 countries from 1981–2010. A second difficulty is that some previous studies have not distinguished between the proportions of surges followed by booms and booms preceded by surges. We found substantial differences between these two relationships. While there is a good deal of variation in the individual correlations the vast majority of the calculated probabilities of a surge being followed by a credit boom fall within the range of 4 % to 13 %. Although the proportion of credit booms preceded by surges is higher, the correlations for both directions are much lower than are frequently assumed. While the probabilities of a surge being followed by a credit boom generally increased from the 1980s to the 1990s they fell again in the 2000s, suggesting the possibility that authorities have become better at limiting the adverse effects of surges on domestic credit growth.

When Do Capital Inflow Surges End in Tears?

We investigate in a sample of 53 emerging markets over 1980-2014 whether countries with open capital accounts are necessarily at the mercy of global events, or are able to take policy actions when receiving inflows to mitigate the impact of a subsequent reversal. Our analysis suggests that, while changes in global conditions have an important bearing on crisis susceptibility, countries that allow the buildup of macroeconomic and financial vulnerabilities during boom times, and which receive mostly debt flows, are significantly more likely to see capital inflow surge episodes end in a financial crisis.

Capital Inflow Surges and Consequences

While capital flows to emerging markets bring numerous benefits, they are also known to create macroeconomic imbalances (economic overheating, currency overvaluation) and increase financial vulnerabilities (domestic credit growth, bank leverage, foreign currency-denominated lending). But are all inflows the same? In this paper, we examine whether the source of the inflow — residents repatriating foreign assets or nonresidents investing in the country — or the type of inflow (foreign direct investment, portfolio, other investment) makes any difference to the consequences of the capital flow. Our results, based on a sample of 53 emerging markets over 1980–2013, show that when it comes to the source of the inflow, the macroeconomic and financial-stability consequences of flows driven by residents (asset flows) and nonresidents (liability flows) are broadly similar in economic terms. Formal statistical tests, however, suggest that liability flows are more prone to causing economic overheating and domestic credit expansion than asset flows. On the types of inflows, we find that compared to direct investment, portfolio debt and other investment flows are associated with larger macroeconomic imbalances and financial vulnerabilities. We conclude that policy should try to mitigate the untoward consequences of inflows, and shift their composition from risky to safer forms of liabilities.

Investment, asset market, and the relative unit labor cost in Mexico

The paper estimates equations for the Mexican/US manufacturing relative unit labor cost (RULC), and finds significant effects from asset market variables like interest rate differentials, foreign reserve accumulation, and international capital flows. The equations are motivated by a simple decomposition that reveals the roles played by relative manufacturing prices and real product wages—and hence the nominal exchange rate—in the upward trend of RULC. The paper follows to estimate equations for aggregate private investment in Mexico, finding a negative RULC effect that agrees with the recent literature on the real exchange rate’s profitability (or development) channel. All the estimations focus on long-run effects, applying the bounds testing approach to quarterly data from 1988 to 2013. The results imply that both the repeated surges in capital inflows and the disinflationary stance of monetary policy in Mexico contributed to the upward trend in RULC, which affected the country’s economic growth negatively by its depressing effect on investment.

Credit booms, financial fragility and banking crises

Using a new country-level panel database, we explore effect of capital inflow surges, credit booms and financial fragility on the probability of banking crises. We find that booms increase the probability of a crisis only in relatively fragile financial systems.

Capital Inflow Surges in Emerging Economies: How Worried Should Latin America and the Caribbean Be?

In the years leading up to the global economic crisis, Latin America and the Caribbean received large capital inflows. Nonetheless, the region survived the (albeit short-lived) dramatic events of 2007-09 reasonably well, with no financial crisis in any of the larger economies. After the crisis, capital inflows rose again: in 2010 gross inflows to seven Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela) amounted to more than 6 percent of gross domestic product (GDP), and net inflows exceeded 3 percent of GDP. More recently following the May 2013 speech of then-Chairman of the U.S. Federal Reserve, Ben Bernanke, there has been concern regarding the potential effects of tapering asset purchases by the U.S. Federal Reserve System and rising interest rates, possibly spelling the end of large capital inflows to the Latin American and Caribbean region.The literature on capital inflows suggests that while these flows represent an opportunity to spur investment and growth, they may also increase vulnerability to financial crises, macroeconomic instability, and ultimately recession. A relevant question, then, is whether the region can declare victory in being able to manage large capital inflows successfully or whether risks remain that justify strong measures.Our starting point is that the region has enjoyed strong surges in capital inflows. We therefore decided to condition the analysis on surges occurring. We do not seek to explain the reasons for such a surge. One justification for this decision is that capital flows appear to be driven as much, if not more, by push rather than pull factors. More specifically, we seek to understand what determines whether such surges end in either a banking crisis or a recession. While there is a substantial literature on the determinants of capital inflows, their potential impacts have received much less attention. The contribution of this paper is to analyze when inflow surges may end in severe economic problems, including financial or macroeconomic instability, rather than to identify the determinants of those surges.We must first tackle the question of how to define a capital inflow surge. We are helped in this regard by a small but growing literature. However, the current definitions of inflow surges in the literature may be injudicious. We propose a new definition which considers the total size of the inflow episode across countries. We also employ a more traditional definition based on yearby-year inflows relative to a country-specific threshold. We contrast relevant statistics on the identified episodes using these two definitions and compare our episodes with others found in the literature.We also consider whether the analysis should be conducted using gross or net inflows. We take the view that employing net flows may discard useful information and that gross flows are relevant where financial instability is a potential concern. Even if net flows are zero, a domestic financial system may intermediate large gross inflows when domestic residents purchase assets abroad. We choose to focus on gross inflows, but we include gross outflows as a potential explanatory variable, so as not to lose information.1The empirical analysis in this paper develops a set of parsimonious models that discriminate reasonably well between the different economic outcomes. We then analyze the case of a typical country from the region with a recent capital inflow surge, providing a set of simulations. To illustrate the economic magnitude of our results, we simulate the changes in the estimated probabilities of negative outcomes given changes in certain critical variables. We suggest that, depending on the country/inflow characteristics, different policy measures may then be justified. However, a caveat is that emerging economies in general and Latin America and the Caribbean in particular have been experimenting with new policy measures, and we are not able to evaluate their potential effectiveness in this paper. …

Capital Inflow Surges in Emerging Economies: How Worried Should Latin America and the Caribbean Be?

Capital Inflow Surges in Emerging Economies:How Worried Should Latin America and the Caribbean Be? Andrew Powell (bio) and Pilar Tavella (bio) In the years leading up to the global economic crisis, Latin America and the Caribbean received large capital inflows. Nonetheless, the region survived the (albeit short-lived) dramatic events of 2007–09 reasonably well, with no financial crisis in any of the larger economies. After the crisis, capital inflows rose again: in 2010 gross inflows to seven Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela) amounted to more than 6 percent of gross domestic product (GDP), and net inflows exceeded 3 percent of GDP. More recently following the May 2013 speech of then-Chairman of the U.S. Federal Reserve, Ben Bernanke, there has been concern regarding the potential effects of tapering asset purchases by the U.S. Federal Reserve System and rising interest rates, possibly spelling the end of large capital inflows to the Latin American and Caribbean region. The literature on capital inflows suggests that while these flows represent an opportunity to spur investment and growth, they may also increase vulnerability to financial crises, macroeconomic instability, and ultimately recession. A relevant question, then, is whether the region can declare victory in being able to manage large capital inflows successfully or whether risks remain that justify strong measures. [End Page 1] Our starting point is that the region has enjoyed strong surges in capital inflows. We therefore decided to condition the analysis on surges occurring. We do not seek to explain the reasons for such a surge. One justification for this decision is that capital flows appear to be driven as much, if not more, by push rather than pull factors. More specifically, we seek to understand what determines whether such surges end in either a banking crisis or a recession. While there is a substantial literature on the determinants of capital inflows, their potential impacts have received much less attention. The contribution of this paper is to analyze when inflow surges may end in severe economic problems, including financial or macroeconomic instability, rather than to identify the determinants of those surges. We must first tackle the question of how to define a capital inflow surge. We are helped in this regard by a small but growing literature. However, the current definitions of inflow surges in the literature may be injudicious. We propose a new definition which considers the total size of the inflow episode across countries. We also employ a more traditional definition based on year-by-year inflows relative to a country-specific threshold. We contrast relevant statistics on the identified episodes using these two definitions and compare our episodes with others found in the literature. We also consider whether the analysis should be conducted using gross or net inflows. We take the view that employing net flows may discard useful information and that gross flows are relevant where financial instability is a potential concern. Even if net flows are zero, a domestic financial system may intermediate large gross inflows when domestic residents purchase assets abroad. We choose to focus on gross inflows, but we include gross outflows as a potential explanatory variable, so as not to lose information.1 The empirical analysis in this paper develops a set of parsimonious models that discriminate reasonably well between the different economic outcomes. We then analyze the case of a typical country from the region with a recent capital inflow surge, providing a set of simulations. To illustrate the economic magnitude of our results, we simulate the changes in the estimated probabilities of negative outcomes given changes in certain critical variables. We suggest that, depending on the country/inflow characteristics, different policy measures may then be justified. However, a caveat is that emerging economies in general and Latin America and the Caribbean in [End Page 2] particular have been experimenting with new policy measures, and we are not able to evaluate their potential effectiveness in this paper. This remains important future work when sufficient experience and data are available, but our results indicate that such policy experimentation does have a prima facie justification. The contributions of this paper thus include a novel analysis of...

Editors’ Summary

Editors’ Summary Raquel Bernal, Marcela Eslava, Ugo Panizza, and Roberto Rigobón This issue of Economía consists of six papers. The first paper looks at the consequence of capital flow surges and discusses policies for mitigating the possible negative effects of these surges. The second studies the links between prudent fiscal management and the effectiveness of macro economic policies. The third shows how better information can nudge workers to save more for their retirement. The fourth demonstrates the presence of peer effects in fertility decisions. The fifth uses twin-birth data to show that birth weight has a large impact on early childhood health. And the last paper, based on Roberto Rigobón’s presidential address at LACEA 2014, discusses what macroeconomists can learn from online price data. In “Capital Inflow Surges in Emerging Economies: How Worried Should Latin America and the Caribbean Be?,” Andrew Powell and Pilar Tavella start by documenting the surge of capital inflows to Latin America after the global financial crisis (they propose a novel definition of “surge” that considers the total size of the gross inflow episode across countries). Next, the authors use a probit model to explore what factors determine whether capital inflow surges lead to a banking crisis or a recession. For the typical episode, they find that surges increase the probability of a banking crisis by 8 percent and the probability of a recession by 24 percent. They also show that the quality of banking supervision is key for reducing the risk of a banking crisis after a capital flow surge and that crises are more likely to happen when portfolio flows dominate the surge. Powell and Tavella conclude the paper by suggesting a set of policy responses, which, depending on the country/inflow characteristics, can mitigate the negative consequences of a capital flow surge. Such policies include reforms in bank regulation and interventions that may affect the composition of inflows and reduce the share of portfolio flows. In “Macroeconomic Gains from Structural Fiscal Policy Adjustments: The Case of Colombia,” Hernando Vargas, Andrés González, and Ignacio [End Page vii] Lozano assess the macroeconomic effect of Colombia’s fiscal policy and public debt management over the past ten years. They analyze the influence of fiscal policy changes on the short-term output response to fiscal shocks with a model that allows structural nonlinear impulse response functions and evaluate monetary policy by identifying policy shocks with a narrative approach similar to the one developed by Romer and Romer. They find that sound fiscal management has improved Colombia’s ability to implement effective countercyclical monetary and fiscal policies. Specifically, they show that sound policies increased the reaction of output to government expenditure shocks and strengthened the response of market interest rates to monetary policy shocks. The authors conclude that sound fiscal policy brings strong countercyclical benefits to both monetary and fiscal actions. In “Knowledge, Information, and Retirement Saving Decisions: Evidence from a Large-Scale Intervention in Chile,” Eduardo Fajnzylber and Gonzalo Reyes exploit a large-scale natural experiment to analyze the impact of personalized pension projection (PPP) statements on retirement savings. The authors compare the saving behavior of individuals during the first twelve months after they received the PPP statement with the saving behavior of comparable individuals who did not receive this statement due to some specific administrative rules. The paper addresses two different issues. First, it tests the full-information hypothesis (if individuals are fully informed, PPP statements should not have any effect on their saving behavior). Second, it explores differences across individuals who belong to different age groups (a test of myopia or liquidity constraints) and also across genders. The paper finds that PPP statements had an effect on savings (individuals who received the statements were more likely to make voluntary contributions) and that this effect was larger for older individuals. This latter result is consistent with the presence of myopia or liquidity constraints. The paper has important policy implications because it shows that small improvements in the information provided by pension administrators can nudge workers toward saving more and help individuals to better align their savings plans with their retirement income goals. In “Peer Effects on a Fertility Decision...

Pattern of capital inflows in BRICS: Aspects to ponder for policy implementation

Surge in capital inflows can stimulate economic growth in developing countries and also lead to macroeconomic fluctuations of varied nature. This makes the analysis of determinants of capital inflows in developing countries interesting. The behavior of capital inflows in the long and short run has been under study. Such analysis could help to avoid undesirable consequences of surge in capital inflows. Traditional literatures on determinants of capital inflows are bifurcated into push and pull factors. The present research focuses on pull factors determining the inflows of capital. This research tries to identify main determinants of capital inflows in BRICS using Vector Autoregression (VAR) technique. Johansen cointegration and Augmented Dickey fuller test are used for data analysis. The Vector Error Correction model (VECM) which is a restricted VAR is used for the analysis since Johansen cointegration test suggested cointegration among the variables in the long run for BRICS. The lag length of the model is determined by performing Schwarz Information Criterion. Impulse response function is used to gauge the effects of shocks on capital inflows with World Bank’s annual data (1992-2012). The variables used in the study include capital inflows (sum of FDI and portfolio equity), inflation, exchange rate, Gross Capital Formation and Gross Domestic Product. All the variables are constant at 2005 U.S. dollars. All the diagnostic testing done for BRICS countries made it relevant to estimate the equations using OLS estimate. In Brazil, capital inflows are influenced by lagged and current values of GDP, GCF and Exchange rate. The Vector Error Correction Model (VECM) estimates of Russian economy indicates cointegration of capital inflows with GDP and Inflation in the long run. Capital inflows in Indian economy is determined by inflation and exchange rate. In China higher GCF plays an important role in attracting capital inflows. In South Africa only inflation is causative factor which determines capital inflows. The Gross Domestic Product is observed to be the vital factor determining the capital inflows to BRICS. The study forecasts improvement of investment climate for attracting capital inflows into BRICS. Economic stability of BRICS is found to be one of the major factors influencing capital inflows in BRICS. The study forecast that in economies of Russia, India and South Africa emergency measures should be taken to curb inflation. Inflation, GDP, GCF and exchange rate are critical factors in attracting capital inflows, which helps in formulating appropriate policies for improving the performance of domestic economy.

Credit Booms and Macroeconomic Dynamics: Stylized Facts and Lessons for Low-Income Countries

Using a comprehensive database on bank credit, covering 135 developing countries over the period 1960–2011, we identify, document, and compare the macro-economic dynamics of credit booms across low- and middle-income countries. The results suggest that while the duration and magnitude of credit booms is similar across country groups, macro-economic dynamics differ somewhat in low-income countries. We further find that surges in capital inflows are associated with credit booms. Moreover, credit booms associated with banking crises exhibit distinct macroeconomic dynamics, while also reflecting a potentially large deviation of credit from country fundamentals. These results suggest that low-income countries should remain mindful of the inter-linkages between financial liberalization, increased cross-border banking activities, and rapid credit growth.

Credit Booms and Macroeconomic Dynamics: Stylized Facts and Lessons for Low-Income Countries

Using a comprehensive database on bank credit, covering 135 developing countries over the period 1960–2011, we identify, document, and compare the macro-economic dynamics of credit booms across low- and middle-income countries. The results suggest that while the duration and magnitude of credit booms is similar across country groups, macro-economic dynamics differ somewhat in low-income countries. We further find that surges in capital inflows are associated with credit booms. Moreover, credit booms associated with banking crises exhibit distinct macroeconomic dynamics, while also reflecting a potentially large deviation of credit from country fundamentals. These results suggest that low-income countries should remain mindful of the inter-linkages between financial liberalization, increased cross-border banking activities, and rapid credit growth.

Countervailing monetary power: Re-regulating capital flows in Brazil and South Korea

ABSTRACTIn the wake of the global financial crisis most emerging market and developing countries experienced a surge in capital inflows that accentuated financial fragility in those countries. Unlike similar surges in the 1990s and in the five years leading to the global financial crisis in 2008, this time many emerging market and developing countries re-regulated cross-border financial flows. According to the literature such acts are seen as quite difficult, given the pervasiveness of the ‘capital mobility hypothesis’ which renders that the structural power of global financial markets is too much of a match for states, especially those in emerging markets. The paper traces how Brazil and South Korea were able to countervail the structural power of global capital markets and put in place regulations on cross-border finance in the wake of the crisis. The paper also outlines the contours an inductive theory regarding the conditions under which emerging market and developing nations may deviate from the ‘capital mobility hypotheses’ and similar literatures. This concept is referred to as ‘countervailing monetary power’.

The effectiveness of monetary policy transmission under capital inflows: Evidence from Asia

The effectiveness of the monetary policy transmission mechanism in open economies could be impaired if interest rates are driven primarily by global factors, especially during periods of large capital inflows. The main objective of this paper is to assess whether this is true for emerging Asia's economies. Using a dynamic factor model and a structural vector autoregression model, we show that long-term interest rates in Asia are indeed predominantly driven by global factors. However, monetary policy transmission mechanism remains effective in the region, as it operates predominantly through short-term interest rates. Nevertheless, the monetary transmission mechanism, though effective, is somewhat weaker in Asia during the periods of surges in capital inflows.

Sudden Stop and Sudden Flood of Foreign Direct Investment: Inverse Bank Run, Output, and Welfare Distribution

AbstractIn this paper, I focus on a phenomenon that has not received much attention in the literature, namely that the mere expectation of foreign direct investment (FDI) incentivizes long‐maturity investment projects by domestic residents, and a Sudden Stop when expectations are frustrated. Long‐maturity investment projects enhance productivity but increase the economy's vulnerability to Sudden Stop. The discussion is framed in a context in which a Sudden Stop follows a surge of capital inflows (Sudden Flood), and FDI is concentrated on ongoing projects. A Sudden Stop episode can trigger a fire sale of long‐term assets, output collapse, and welfare redistribution, which is another ignored phenomenon.

Capital Flows to India Since Nineties

Foreign capital supplements domestic savings and stimulates economic growth. Moreover, it enables countries to counterbalance fluctuations in income and attain smooth consumption flows. Capital inflows can help developing countries with economic development by providing them with necessary capital and technology. It relaxes two major constraints to economic growth i.e. resource gap and foreign-exchange gap. However, surge in capital flows have had associated problems as it may lead to exchange rate appreciation, excessive accumulation in foreign exchange reserves etc. Large and volatile capital flows may destabilize macroeconomic management. Since economic reforms India has undertaken various policy measures to liberalize capital inflows which has resulted in significant increase in amount of capital inflows and changed its composition. Capital inflows have undergone a compositional shift from predominantly official and private debt flows to non-debt-creating flows in the post-reform period. This paper focuses on various facets of capital flows to India and attempts to analyze the patterns and trends in capital flows to India since 1990s. The paper also discusses issues and challenges associated with surge in capital inflows.

Coping with Capital Inflow Surges: Reviewing the IMF’s New ‘Institutional View’

Coping with Capital Inflow Surges: Reviewing the IMF’s New ‘Institutional View’

ABS inflows to the United States and the global financial crisis

Relative to the “global savings glut” (GSG) hypothesis, we present a more complete picture of how capital flows contributed to the financial crisis, drawing attention to the sizable inflows from European investors into U.S. private-label asset-backed securities (ABS), including mortgage-backed securities and other structured investment products. The GSG hypothesis argues that the surge in capital inflows from emerging market economies to the United States led to significant declines in long-term interest rates in the United States and other industrial economies. In turn, these lower interest rates, when combined with both innovations and deficiencies of the U.S. credit market, are believed to have contributed to the U.S. housing bubble and to the buildup in financial vulnerabilities that led to the financial crisis. Because the GSG countries for the most part restricted their U.S. purchases to Treasuries and Agency debt, their provision of savings to ultimately risky subprime mortgage borrowers was necessarily indirect, pushing down yields on safe assets and increasing the appetite for alternative investments on the part of other investors. Foreign acquisitions of private-label ABS, primarily by Europeans, provided credit more directly and, by adding to domestic demand for these securities, contributed to the decline in their spreads over Treasury yields. Through a combination of empirical estimation and model simulation, we verify that both GSG inflows into Treasuries and Agencies, as well as European acquisitions of ABS, played a role in contributing to downward pressures on U.S. interest rates.

Episodes of Large Capital Inflows, Banking and Currency Crises, and Sudden Stops

AbstractThis paper empirically investigates the relationship between surges in capital inflows and the probability of subsequent banking, currency and balance‐of‐payment crises. Using a panel of developed and emerging economies from 1970 to 2007, it shows that a large capital inflow episode increases substantially the probability of having a banking or a currency crisis in the two following years. The effect is especially large for the case of balance‐of‐payment crises. The paper also finds that the effect of large capital inflows is different depending on the type of flows characterizing the episode. In particular, large capital inflows that are debt driven significantly increase the probability of banking, currency and balance‐of‐payment crises, whereas inflows that are driven by equity portfolio investment or foreign direct investment have a negligible effect.

THE TRANSFER PROBLEM IN INDONESIA AND POLICY RESPONSES

This paper examines the implications of, and policy responses to the transfer problem phenomenon, which is the interaction between surging capital inflows and real exchange rate. In particular, this paper identifies three episodes of large net private capital inflow to Indonesia during 1995 - 2010. Episodes of large capital inflows are often associated with real exchange rate appreciations. In turn, these conditions could undermine economic competitiveness in terms of price. This paper adopts theoretical framework that leads to test the long-run co-movements of real exchange rates and capital inflows. This long run relationship is modeled on the cointegration framework. The Full-Modified Ordinary Least Square (FMOLS) is used to provide optimal estimates of cointegration regressions, dealing with endogeneity and serial correlation effect in the regressors that result from the existence of the cointegrating relationships. Controlling for relative output levels, degree of openness, and the terms of trade, time series empirical evidence presented evidence supporting the existence of a significant transfer problem in Indonesia. Moreover, using disaggregated measure of inflows, this paper finds that portfolio investment has the most significant impact on REER appreciation in Indonesia. A comprehensive assessment of various policy responses to the transfer problem leads to two major conclusions. First, the problematic relationship between REER apreciation and capital inflows would be more moderate in which the authorities exercised countercyclical fiscal. It means that greater fiscal restraint would also help ease pressures for real appreciation of the exchange rate. Second, aggressive sterilization could be the first line of defense against REER apreciation during surge of capital inflows. Keywords: Transfer Problem, Real Effective Exchange Rate, Capital Inflows, Cointegration, Full-Modified Ordinary Least Squared (FMOLS)

Capital Controls and Spillover Effects: Evidence from Latin-American Countries

The surge in capital inflows towards emerging countries after 2009 has revived the debate about capital controls. This paper analyzes some of the international implications of restrictions on capital inflows. Focusing on a sample of Latin-American countries, we use detailed balance of payments data and higher frequency data on portfolio bond and equity flows to investigate the potential spillover effects that capital controls imposed in one country may have on neighboring economies. Using various econometric approaches, we find that a rise in the Brazilian tax on portfolio bond inflows has been affecting other Latin-American economies through significant surges in portfolio funds invested either in fixed income or equity securities. The effect is usually short lasting and followed by rapid reductions in those inflows. Yet it can be large. According to our estimates, the increase in the Brazilian tax on portfolio bond inflows may account for the entire surge in bond inflows to Mexico between September and October 2010.