Tag: International Finance

Must-read: Wolfgang Munchau: “Free Capital Flows Can Put Economies in a Bind”

Posted on by Brad DeLong

Must-Read: Wolfgang Münchau: Free Capital Flows Can Put Economies in a Bind: “We might now ask whether the removal of the policy instrument of capital controls may have contributed to a succession of financial crises…

…In the good times, Prof Rey finds, credit flows into emerging markets where it fuels local asset price bubbles. When, years later, liquidity dries up and the hot money returns to safe havens in North America and Europe, the country is left in a mess. There is very little the central bank can do to moderate inflows and outflows of foreign money. Unless you accept financial instability as inevitable, then, you may soon be thinking about imposing capital controls of a particularly stubborn variety–the kind that involves telling foreign investors you do not want their cash. The point is to prevent hot money flowing in during the good times, and to stop it from draining out in the bad times. This is not yet a subject of polite conversation among policymakers. Central bankers have instead been peddling a concept known as macroprudential regulation, a cuddly version of capital controls…

Must-read: Olivier Blanchard et al.: “Macro Effects of Capital Inflows: Capital Type Matters”

Posted on by Brad DeLong

Olivier Blanchard et al.: Macro Effects of Capital Inflows: Capital Type Matters: “Some scholars view capital inflows as contractionary…

…but many policymakers view them as expansionary. Evidence supports the policymakers. This column introduces an analytic framework that knits together the two views. For a given policy rate, bond inflows lead to currency appreciation and are contractionary, while non-bond inflows lead to an appreciation but also to a decrease in the cost of borrowing, and thus may be expansionary….

How can we reconcile the models and reality? [Our] answer… relies on… allowing for both ‘bonds’ (the rate on which can be thought of as the policy rate) and ‘non-bonds’… which are imperfect substitutes…. Capital inflows may decrease the rate on non-bonds and reduce the cost of financial intermediation…. Capital inflows may in this case be expansionary even for a given policy rate. In emerging markets, with a relatively underdeveloped financial system, the effect of a reduction in the cost of financial intermediation may dominate, leading to a credit boom and an output increase despite the appreciation. In more advanced economies, the appreciation may dominate, and capital inflows (even into non-bonds) may be contractionary (e.g. the Swiss case)….

The appropriate policies vis-à-vis capital inflows depend very much on the nature of the inflows.

Sterilised foreign exchange (FX) market intervention, if done through bonds (as is usually the case), can fully offset the effects of bond inflows…. When, however, sterilised foreign exchange intervention is used in response to non-bond inflows… FX intervention… by reducing upward pressure on the currency… increases capital inflows, and thus increases the effects of inflows on credit and the financial system….

The policymaker may have several objectives in mind – with respect to credit growth (given the risk of financial crisis); the currency (given the risk of Dutch disease); and output (given nominal rigidities in the system). The issue is really one of matching the policy instrument (there are three) to deliver on the most important objectives, without too much cost in terms of the other objectives…. If the central bank is worried about both appreciation and unhealthy or excessive credit growth, FX intervention or capital controls are preferable to the use of the policy rate in response to an increase in bond inflows…. In response to non-bond inflows, our framework suggests that if the goal is to maintain exchange rate stability with minimum impact on the return to non-bonds, capital controls do the job best, followed by FX intervention, followed by a move in the policy rate….

[We] use global flows to all emerging market countries together with the VIX as instruments…. We find that, while bond inflows have a negative effect on economic activity, non-bond inflows have a significant and positive effect. We also find that non-bond inflows (excluding FDI) have a strong positive effect on credit…. FDI inflows, while they increase output, have a negative impact on credit, perhaps because some of the intermediation which would have taken place through banks is replaced by FDI financing…

Must-read: Bloomberg View: “Congress Should Care About the IMF”

Posted on by Brad DeLong

Must-Read: Bloomberg View: Congress Should Care About the IMF: “Since 2010, Washington’s paralysis has blocked badly needed changes at the International Monetary Fund…

…The [budget] bill will let them go forward. This is good news. It serves U.S. as well as global interests. But the protracted delay draws attention to a deeper problem, still unresolved: Rather than lead the IMF in its vital work, the U.S. continues to settle for the role of glum bystander. Five years ago, IMF members agreed, among other things, to increase the fund’s financial resources and rebalance countries’ voting power…. Congressional approval was needed, and this is only now being granted…. The U.S., out of negligence rather than calculation, has said it isn’t much interested in having an up-to-date IMF and can’t be bothered to recognize the new standing of China and other big emerging economies…. Doesn’t the spending bill put this right, finally? Better late than never? That would be generous…. Reforming the IMF by stealth, after prolonged delay, is better than not doing it all. For its own sake, and everybody else’s, the U.S. should aim a bit higher than that.