I show that monetary policy divergence vis-a-vis the U.S. has larger spillover effects in emerging markets than advanced economies. The monetary policy of the U.S. affects domestic credit costs in other countries through its effect on global investors’ risk perceptions. Capital flows in and out of emerging market economies are particularly sensitive to fluctuations in such risk perceptions and have a direct effect on local credit spreads. Domestic monetary policy is ineffective in mitigating this effect as the pass-through of policy rate changes into short-term interest rates is imperfect. This disconnect between short rates and monetary policy rates is explained by changes in risk perceptions. A key policy implication of my findings is that emerging markets’ monetary policy actions designed to limit exchange rate volatility can be counterproductive.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

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U.S. Monetary Policy and International Risk Spillovers

This study quantifies the importance of a Global Financial Cycle (GFCy) for capital flows. We use capital flow data dis-aggregated by direction and type between 1990Q1 and 2015Q5 for 85 countries, and conventional techniques, models and metrics. Since the GFCy is an unobservable concept, we use two methods to represent it: directly observable variables in center economies often linked to it, such as the VIX; and indirect manifestations, proxied by common dynamic factors extracted from actual capital flows. Our evidence seems mostly inconsistent with a significant and conspicuous GFCy; both methods combined rarely explain more than a quarter of the variation in capital flows. Succinctly, most variation in capital flows does not seem to be the result of common shocks nor stem from observables in a central country like the United States.

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How Important is the Global Financial Cycle? Evidence from Capital Flows

It is surprisingly difficult to find economic variables that strongly co-move with exchange rates, a phenomenon codified in a large literature on “exchange rate disconnect.” We demonstrate that a v...

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Exchange Rate Reconnect

In this paper, we study the effects of structural shocks that influence global risk – the main factor behind a “global capital flows cycle” – and how risk, in turn, is transmitted to capital flows. Our results show that not all the risk shocks driving the global financial cycle have the same effects on capital flows. Changes in global risk caused by pure financial shocks have the largest impact on the global configuration of capital flows, followed by US monetary policy shocks. As regards the transmission of risk to capital flows, we uncover a traditional “trilemma”, as countries more financially open and adopting a strict peg are more sensitive to global risk. This “trilemma” is mainly driven by one category of cross-border flows, “other investment”, confirming the importance of cross-border banking loans in the narrative of the global financial cycle. JEL Classification: E42, E52, F31, F36, F41

The global capital flows cycle: structural drivers and transmission channels

We document five novel facts about Uncovered Interest Parity (UIP) deviations vis-a-vis the U.S. dollar for 34 currencies of advanced economies and emerging markets, using survey data on expected exchange rate. First, the UIP premium co-moves with global risk perception (VIX) for all currencies, whereas only for emerging market currencies there is a negative comovement between the UIP premium and capital inflows. Second, the comovement of the UIP premium and the VIX is explained by changes in interest rate differentials in emerging markets, and by expected changes in exchange rates in advanced countries. Third, country risk measured by the degree of policy uncertainty can explain both the negative comovement of the UIP premium with capital inflows and the positive comovement of the UIP premium with the interest rate differentials in emerging markets. Fourth, there are no overshooting and predictability reversal puzzles - for any currency - when using exchange rate expectations to calculate the UIP premium. Fifth, the classical Fama puzzle disappears in advanced economies in expectations, but it remains for emerging markets. As a result, while global investors expect zero excess returns and earn positive returns in the short-run and negative returns in the long-run by investing in advanced country currencies, the same global investors always expect and earn positive excess returns from emerging market currencies. These results imply that in advanced countries the UIP premium is largely due to deviations from rational expectations and full information, whereas in emerging markets, the UIP premium is a risk premium. Global investors charge an "excess" premium to compensate for policy uncertainty in emerging markets - a premium that is over and above the expected and actual depreciation of these currencies.

Five Facts about the UIP Premium

We construct a new data set for gross capital inflows during 1996-2014 for 85 countries at a quarterly frequency. We decompose debt inflows by borrower type: banks, corporates and sovereigns. Using our new data, we present dynamic and cross sectional patterns in capital inflows as a function of global push factors and countries' own business cycles. This exercise reveals that patterns evident in aggregate capital flows data do not hold up consistently across different borrower types. When global risk appetite is low, as proxied by high VIX, capital flows into banks and corporates decline both in advanced economies (AE) and in emerging markets (EM). This is also true for EM sovereigns but not for AE, whose sovereign borrowing does not respond to VIX. Banks' and corporates' borrowing, both in EM and in AE are procyclical, whereas EM's sovereigns exhibit counter-cyclical borrowing. Capital inflows are procyclical in all assets classes except for portfolio debt inflows to EM, which exhibit a countercyclical pattern driven mainly by EM sovereigns and to some extent by EM corporates. Our results highlight the importance of separating capital flows by borrower type for understanding potential systemic risks related to capital flows, and show the difficulty of establishing robust stylized facts about capital flows' dynamics in a mixed sample of emerging and advanced countries.

Gross capital flows by banks, corporates, and sovereigns

Abstract We construct a new quarterly data set of international capital flows broken down by sector—banks, corporates, and sovereigns—and demonstrate the importance of distinguishing capital flows by the sector of domestic borrowers and lenders. We document four new sets of facts. First, banks account for the largest part of the external debt (stocks and flows) in advanced economies, whereas in emerging markets, banks, corporates, and sovereigns have roughly equal shares. Second, the high correlation between total capital inflows and outflows documented in the literature is driven by banking sector flows; that is, domestic banks’ borrowing from foreigners is highly correlated with domestic banks’ lending to foreigners. Third, sovereign flows behave very differently from and often act as a countervailing force to private sector (banking and corporate) flows, especially in emerging markets. Fourth, different shocks (global financial cycles versus domestic business cycles; banking versus currency versus sovereign crises) generate very distinct patterns of capital inflows and outflows by sector. The stylized facts we document deepen our understanding of the dynamics and behavior of capital flows and have important implications for open economy models. 

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Gross Capital Flows by Banks, Corporates, and Sovereigns

Abstract We show that the welfare of a country’s infinitely lived representative consumer is summarized, to a first order, by total factor productivity (TFP), appropriately defined, and by the capital stock per capita. The result holds for both closed and open economies, regardless of the type of production technology and the degree of product market competition. Welfare-relevant TFP needs to be constructed with prices and quantities as perceived by consumers, not firms. Thus, factor shares need to be calculated using after-tax wages and rental rates. We use these results to calculate welfare gaps and growth rates in a sample of developed countries with high-quality data on output, hours worked, and capital. We also present evidence for a broader sample that includes both developed and developing countries. 

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PRINCE2-Agile-Foundation Exam Dumps

Papers

Gross capital flows by banks, corporates, and sovereigns

Gross Capital Flows by Banks, Corporates, and Sovereigns

Productivity and the Welfare of Nations