capital ﬂows: stabilizing or destabilizing · the postwar period has been characterized by...

IntroductionCapital mobility and exchange rate regime

Sudden stops

Capital flows: Stabilizing or DestabilizingHave capital flows been stabilizing or destabilizing?

Yeganeh Forouheshfar

Problèmes contemporains en macro-économie internationale15 Fev. 2012

Yeganeh Forouheshfar Capital flows: Stabilizing or Destabilizing


Sudden stops

Outline

1 IntroductionIn the pastTypes of capital control

2 Capital mobility and exchange rate regimeMonetary unionCapital controls

3 Sudden stops



Sudden stops

In the pastTypes of capital control

History of capital mobility

Since 1944 liberalization of capital movements has beenencouraged by IMF to allow for an optimal allocation of worldsavings (from rich countries to poor countries)Throughout the 1990s, capital movement liberalization was partof the “Washington consensus” and was imposed by theG7,OECD and IMF on many emerging nations1990s twin banking and currency crisis in Asia and MexiqueMost capital flows were “north-north” rather than “north-south”Welfare gains were much lower than previously thoughtIMF took a more benign approach : “High openness tointernational capital flows can be dangerous for countries withweak or inconsistent macro-economic policies or inadequatelycapitalized and regulated financial systems ”



Sudden stops


Types of captal control

Administrative control of foreign exchange operationsalmost all counties have some control on capital transactions(sometime for security reasons)Actions based on incentives rather than control

Leave a min reserves at the central bank as an interest free deposit(90s in Chili)Tobin tax : Tax on foreign exchange transactions

The control is not advisable in the long run!



Sudden stops


Has capital mobility increased?

In the late nineteenth century capital markets were relatively wellintegrated under the classic gold standard centered on LondonThe interwar period was the time of disintegration and imperfectcapital mobility, specially after 1929.The postwar period has been characterized by gradually increasingcapital market integration. (Tylor 1996)

We have same order of magnitude of capital mobility as theinternational gold standard (a century ago)The degree of financial integration in the world has beenincreasing in the last few decades



Sudden stops


Capital mobility: pros and cons

Models of perfect markets suggest that international capitalmovements benefit both borrowers and lenders↑ capital mobility ⇒ ↑ exchange rate volatility↑ capital mobility ⇒ greater credibility of low inflation policiesperfect capital mobility ⇒ better allocation of investment (is italways true?)



Sudden stops




Sudden stops

Monetary unionCapital controls

Impact of the capital mobility on the exchange rateregime

Increase in capital mobility:↑ fragile fixed exchange rate regime (speculative attacks)↑ contagious effects of crises (second generation models)

The number of countries pegging their currencies dropped byhalf during 1975-1998

ConsensusIntermediate regime of pegging is not sustainable for long in a worldof high capital mobility

The increasing degree of capital mobility puts countries in to theuncomfortable situation of having to choose for more flexibility ormuch tighter arrangements



Sudden stops


Different exchange rate regime choices and theirflexibility level



Sudden stops


A tendency toward extreme regimes!?



Sudden stops


Which exchange rate regime?

Extreme exchange regimes :

More flexibility:Float:

VolatileNeed to anchor nominalvariables (domestic price levels)Inflation targetingTend to stabilize exchange rates

More rigidity:Currency board:

Performed wellinflationout put

weak points:speculative attackfragiledifficult transition

Monetary union



Sudden stops


Under a monetary union:

Countries with tighter exchange rate arrangements → increasemonetary cooperation (because the interest rates of the membercountries should equalized)EMU affect spillover effects of fiscal policies

Intense trade links : price transparency and competitionIntense financial integration (through the interest rate chanel)

Stability pact

The fear that excessive budget deficits and debt levels in one countrywould affect other countries through the interest rate channel : controlfiscal policies

Problem: spillovers ↑ , but the sign of the impact on economicactivities are different ⇒ total spillover may or may not increasethe output level of EMU



Sudden stops


Financial integration

Financial integration →income convergence within theintegrating area (convergence club)→ faster growth in the morebackward countries (through domestic saving and also byresources generated in the more advanced economies).capital flows from developed economies to developing onesIn the standard neoclassical framework, internationally opencapital markets generate capital flows from capital-abundantdeveloped countries, where the return to capital is low, tocapital-scarce developing countries, where it is high. The lattershould therefore experience a foreign-financed increase ininvestment and growth. But skeptics argue that the opening ofcapital markets triggers speculation and the recurrence of marketcrises



Sudden stops


A need for coordination

It is unclear wether a more intense coordination of fiscal policiesin EMU will increase welfare:

The use of fiscal policies creates public good effects ⇒ anincentive to spend too littleShift part of the financing costs of the expanding country to othermembers ⇒ incentive to spend too much

Asymmetric shocks are likely to occur in a monetary union ⇒ aninsurance mechanism:

Unified budget (not set for EMU)Individual nations should use their fiscal policies to absorbasymmetric shocks (difficult cooperation)Financial integration (equally powerful as a unified budget)



Sudden stops


Tobin Tax

A penalty on short-term financial round-trip excursions into anothercurrency.(0.05 or 1%)

Making exchange rate less volatile:Only 5% of exchange transactions is due to imports and exports80% of daily transactions are for purposes of hedging and notspeculation!!!The existence of many dealers : efficient risk spreading mechanismTaxing all transactions in the foreign market ⇒ (?) less volatility

Making fixed exchange rate less fragile:Speculative attacks on a pegged currency are driven byexpectations of relatively high devaluations (20% or more)Tobint tax of 1% will do little to discourage panic flows⇒ Tobin tax will do little to reduce exchange rate volatility



Sudden stops

Perfect capital mobility and sudden stopsEmpirical analysis : looking for large and unexpected fall in capitalflows:



Sudden stops

Results

EM: 63% of the depreciation episodes is associated with asudden stopDeveloped: 17% of the depreciation episodes is associated witha sudden stopLarge RER fluctuations accompanied by sudden stops arebasically an EM phenomenonDeveloped countries can sustain large depreciations whilekeeping their capital account openSudden stops ⇒ interest rate ↑, reserves ↓ , current accountadjustmentKey determinants of the probability of a sudden stop :

OpennessDomestic liability dolarization



Sudden stops

Bibliography

Agnès Bénassy-Quéré, Benoît Coeuré, Pierre Jacquet and JeanPisani-FerryEconomic policy theory and practiceOxford University Press, 2010

John Driffill and Daniel GrosThe stability and sustainability of the Euro- pean MonetarySystem with perfect capital marketspages 211–231 Cambridge University Press, 1988.

Paul De Grauwe Magdalena PolanIncreased Capital Mobility: A Challenge for NationalMacroeconomic PoliciesUniversity of Leuven 2000

Guillermo A Calvo and Carmen ReinhartWhen Capital Inflows Come to a Sudden Stop: Consequencesand Policy OptionsUniversity of Maryland 2000



Sudden stops

Bibliography

Guillermo A. Calvo , Alejandro Izquierdo and Luis-FernandoMejíaOn the Empirics of Sudden Stops: The Relevance ofBalance-Sheet EffectsJuly 2004

Barry EichengreenCapital Account-Liberalization: What Do Cross-Country StudiesTell Us?The world bank economic review, volume15 , 2001, Number 3

PETER BLAIR HENRYCapital Account Liberalization: Theory, Evidence, andSpeculationJournal of Economic Literature Vol. XLV (December 2007), pp.887–935


capital ﬂows: stabilizing or destabilizing · the postwar period has been characterized by...

Documents