nep-ifn New Economics Papers
on International Finance
Issue of 2012‒03‒28
thirteen papers chosen by
Vimal Balasubramaniam
National Institute of Public Finance and Policy

  1. Capital controls and foreign exchange policy By Fratzscher, Marcel
  2. International reserves and gross capital flows. Dynamics during financial stress By Enrique Alberola; Aitor Erce; José María Serena
  3. Liquidity, Risk and the Global Transmission of the 2007-08 Financial Crisis and the 2010-11 Sovereign Debt Crisis By Chudik, Alexander; Fratzscher, Marcel
  4. Does the Current Account Still Matter? By Obstfeld, Maurice
  5. Capital Inflows and Asset Prices: Evidence from Emerging Asia By Peter Tillmann
  6. Financial Repression and External Imbalances By Johansson, Anders C.; Wang, Xun
  7. Sources of Risk in Currency Returns By Chernov, Mikhail; Graveline, Jeremy; Zviadadze, Irina
  8. Growth under Exchange Rate Volatility: Does Access to Foreign or Domestic Equity Markets Matter? By Demir, Firat
  9. Nominal Stability and Financial Globalization By Devereux, Michael B; Senay, Ozge; Sutherland, Alan
  10. Capital Controls with International Reserve Accumulation: Can this Be Optimal? By Bacchetta, Philippe; Benhima, Kenza; Kalantzis, Yannick
  11. The transmission process of financial crises across the emerging markets: an alternative consideration By Abdurrahman, Korkmaz
  12. International Capital Flows with Limited Commitment and Incomplete Markets By von Hagen, Jürgen; Zhang, Haiping
  13. International shock transmission after the Lehman Brothers collapse – evidence from syndicated lending By Ralph De Haas; Neeltje Van Horen

  1. By: Fratzscher, Marcel
    Abstract: The empirical analysis of the paper suggests that an FX policy objective and concerns about an overheating of the domestic economy have been the two main motives for the (re-)introduction and persistence of capital controls over the past decade. Capital controls are strongly associated with countries having significantly undervalued exchange rates. Capital controls also appear to be less motivated by worries about financial market volatility or fickle capital flows per se, but rather by concerns about capital inflows triggering an overheating of the economy--in the form of high credit growth, rising inflation and output volatility. Moreover, countries with a high level of capital controls, and those actively implementing controls, tend to be those that have fixed exchange rate regimes, a non-IT monetary policy regime and shallow financial markets. This evidence is consistent with capital controls being used, at least in part, to compensate for the absence of autonomous macroeconomic and prudential policies and effective adjustment mechanisms for dealing with capital flows.
    Keywords: capital controls; capital flows; economic policy; exchange rates; financial stability; G20
    JEL: F30 F31
    Date: 2012–01
  2. By: Enrique Alberola (Banco de España); Aitor Erce (Banco de España); José María Serena (Banco de España)
    Abstract: This paper explores the role of international reserves as a stabilizer of international capital flows during periods of global financial stress. In contrast with previous contributions, aimed at explaining net capital flows, we focus on the behavior of gross capital flows. We analyze an extensive cross-country quarterly database using event analyses and standard panel regressions. We document significant heterogeneity in the response of resident investors to financial stress and relate it to a previously undocumented channel through which reserves are useful during financial stress. International reserves facilitate financial disinvestment overseas by residents, offsetting the simultaneous drop in foreign financing
    Keywords: Gross capital flows, international reserves, systemic crises, capital retrenchment
    JEL: F21 F32 F33
    Date: 2012–02
  3. By: Chudik, Alexander; Fratzscher, Marcel
    Abstract: The paper analyses the transmission of liquidity shocks and risk shocks to global financial markets. Using a Global VAR methodology, the findings reveal fundamental differences in the transmission strength and pattern between the 2007-08 financial crisis and the 2010-11 sovereign debt crisis. Unlike in the former crisis, emerging market economies have become much more resilient to adverse shocks in 2010-11. Moreover, a flight-to-safety phenomenon across asset classes has become particularly strong during the 2010-11 sovereign debt crisis, with risk shocks driving down bond yields in key advanced economies. The paper relates this evolving transmission pattern to portfolio choice decisions by investors and finds that countries' sovereign rating, quality of institutions and their financial exposure are determinants of cross-country differences in the transmission.
    Keywords: advanced economies; capital flows; emerging market economies; global financial crisis; high dimensional VARs; liquidity; risk; sovereign debt crisis; transmission
    JEL: C5 E44 F3
    Date: 2012–01
  4. By: Obstfeld, Maurice
    Abstract: Do global current account imbalances still matter in a world of deep international financial markets where gross two-way financial flows often dwarf the net flows measured in the current account? Contrary to a complete markets or 'consenting adults' view of the world, large current account imbalances, while very possibly warranted by fundamentals and welcome, can also signal elevated macroeconomic and financial stresses, as was arguably the case in the mid-2000s. Furthermore, the increasingly big valuation changes in countries’ net international investment positions, while potentially important in risk allocation, cannot be relied upon systematically to offset the changes in national wealth implied by the current account. The same factors that dictate careful attention to global imbalances also imply, however, that data on gross international financial flows and positions are central to any assessment of financial stability risks. The balance sheet mismatches of leveraged entities provide the most direct indicators of potential instability, much more so than do global imbalances, though the imbalances may well be a symptom that deeper financial threats are gathering.
    Keywords: Current account; External adjustment problems; Financial stability; Global imbalances; Gross financial flows; Intertemporal budget constraint; Net international investment position
    JEL: F32 F34 F36
    Date: 2012–03
  5. By: Peter Tillmann (University of Giessen)
    Abstract: The withdrawal of foreign capital from emerging countries at the height of the recent financial crisis and its quick return sparked a debate about the impact of capital flow surges on asset markets. This paper addresses the response of property prices to an inflow of foreign capital. For that purpose we estimate a panel VAR on a set of Asian emerging market economies, for which the waves of inflows were particularly pronounced, and identify capital inflow shocks based on sign restrictions. Our results suggest that capital inflow shocks have a significant effect on the appreciation of house prices and equity prices. Capital inflow shocks account for - roughly - twice the portion of overall house price changes they explain in OECD countries. We also address crosscountry differences in the house price responses to shocks, which are most likely due to differences in the monetary policy response to capital inflows.
    Keywords: Capital Inflows, House Prices, Monetary Policy, Sign Restrictions, Panel VAR
    JEL: F32 F41 E32
    Date: 2012
  6. By: Johansson, Anders C. (China Economic Research Center); Wang, Xun (China Economic Research Center)
    Abstract: This paper examines how repressive financial policies influence external balances. We argue that financial repression holds back financial development and distorts the process of structural transformation by constraining the service sector and promoting the manufacturing sector, thereby affecting external balances. Using a panel data set of a large number of countries, we find that financial repression has a significant and positive effect on the current account. This result holds for several additional robustness checks, including using medium-term determinants of the current account, alternative measures of external balances, and alternative measures of financial repression. We also show that financial repression mainly affects external balances through its effect on economic structure. When analyzing different repressive financial policies, we find that interest rate controls and capital account controls are the main policies contributing to external imbalances. Furthermore, financial repression has a larger effect on the current account in East Asia than the rest of the world.
    Keywords: External imbalances; Current account; Financial repression; Financial development; Institutional development
    JEL: F32 F41
    Date: 2012–03–19
  7. By: Chernov, Mikhail; Graveline, Jeremy; Zviadadze, Irina
    Abstract: We quantify the sources of risk in currency returns as a first step toward understanding the returns reported for the carry trade. To do this, we develop and estimate an empirical model of exchange rate dynamics using daily data for four currencies relative to the US dollar: the Australian dollar, the British pound, the Swiss franc, and the Japanese yen. The model includes (i) Gaussian shocks with stochastic variance, (ii) jumps up and down in the exchange rate, and (iii) jumps in the variance. We identify these components using data on exchange rates and at-the-money implied variances. We find that the probability of a jump depreciation (appreciation) in the exchange rate is increasing in the domestic (foreign) interest rate. The probability of jumps in variance is increasing in the variance but not related to interest rates. Many of the jumps in exchange rates are associated with macroeconomic and political news, but jumps in variance are not. Overall, jumps account for 25% of total currency risk over horizons of one to three months.
    Keywords: Bayesian MCMC; carry trades; exchange rates; implied volatility; jumps
    JEL: C58 F31 G12
    Date: 2012–01
  8. By: Demir, Firat
    Abstract: Employing a matched employer-employee dataset, this paper explores the effects of exchange rate volatility on the growth performances of domestic versus foreign, and publicly traded versus non-traded private manufacturing firms in a major developing country, Turkey. The empirical results using dynamic panel data estimation techniques and comprehensive robustness tests suggest that exchange rate volatility has a significant growth reducing effect on manufacturing firms. However, having access to foreign, and to a lesser degree, domestic equity markets is found to reduce these negative effects at significant levels. These findings continue to hold after controlling for firm heterogeneity due to differences in export orientation, external indebtedness, profitability, productivity, size, industrial characteristics, and time-variant institutional changes.
    Keywords: Growth; Foreign Direct Investment; Capital Structure; Exchange Rate Volatility; Manufacturing Sector
    JEL: F22 G31 G15 G32 F31
    Date: 2011–09–01
  9. By: Devereux, Michael B; Senay, Ozge; Sutherland, Alan
    Abstract: Over the one and a half decades prior to the global financial crisis, advanced economies experienced a large growth in gross external portfolio positions. This phenomenon has been described as Financial Globalization. Over roughly the same time frame, most of these countries also saw a substantial fall in the level and variability of inflation. Many economists have conjectured that financial globalization contributed to the improved performance in the level and predictability of inflation. In this paper, we explore the causal link running in the opposite direction. We show that a monetary policy rule which reduces inflation variability leads to an increase in the size of gross external positions, both in equity and bond portfolios. This is a highly robust prediction of open economy macro models with endogenous portfolio choice. It holds across many different modeling specifications and parameterizations. We also present preliminary empirical evidence which shows a negative relationship between inflation volatility and the size of gross external positions.
    Keywords: Country Portfolios; Financial Globalization; Nominal stability
    JEL: E52 E58 F41
    Date: 2012–02
  10. By: Bacchetta, Philippe; Benhima, Kenza; Kalantzis, Yannick
    Abstract: Motivated by the Chinese experience, we analyze a semi-open economy where the central bank has access to international capital markets, but the private sector has not. This enables the central bank to choose an interest rate different from the international rate. We examine the optimal policy of the central bank by modelling it as a Ramsey planner who can choose the level of domestic public debt and of international reserves. The central bank can improve savings opportunities of credit-constrained consumers modelled as in Woodford (1990). We find that in a steady state it is optimal for the central bank to replicate the open economy, i.e., to issue debt financed by the accumulation of reserves so that the domestic interest rate equals the foreign rate. When the economy is in transition, however, a rapidly growing economy has a higher welfare without capital mobility and the optimal interest rate differs from the international rate. We argue that the domestic interest rate should be temporarily above the international rate. We also find that capital controls can still help reach the first best when the planner has more fiscal instruments.
    Keywords: Capital controls; International reserves
    JEL: E58 F36 F41
    Date: 2012–01
  11. By: Abdurrahman, Korkmaz
    Abstract: This paper offers an alternative consideration for the transmission process of financial crises across emerging markets. Here, we hypothesized that the interdependence effect could weaken, even disappear completely, and veer during a crisis period as a result of the contagion process. The importance of this hypothesis for the policy implication is also highlighted because it can be validated for many cases by our data.
    Keywords: contagion; interdependence; outlier test; financial crisis
    JEL: C32 C12 G01
    Date: 2012–03–17
  12. By: von Hagen, Jürgen; Zhang, Haiping
    Abstract: Recent literature has proposed two alternative types of financial frictions, i.e., limited commitment and incomplete markets, to explain the patterns of international capital flows between developed and developing countries observed in the past two decades. This paper integrates both types of frictions into a two-country overlapping-generations framework to facilitate a direct comparison of their effects. In our model, limited commitment distorts the investment made by agents with different productivity, which creates a wedge between the interest rates on equity capital vs. credit capital; while incomplete markets distort the investment among projects with different riskiness, which creates a wedge between the risk-free rate and the mean rate of return to risky capital. We show that the two approaches are observationally equivalent with respect to their implications for international capital flows, production efficiency, and aggregate output.
    Keywords: financial development; financial frictions; foreign direct investment; international capital flows; limited commitment
    JEL: E44 F41
    Date: 2012–01
  13. By: Ralph De Haas (EBRD); Neeltje Van Horen (De Nederlandsche Bank)
    Abstract: After Lehman Brothers filed for bankruptcy in September 2008, cross-border bank lending contracted sharply. To explain the severity and variation in this contraction, we analyse detailed data on cross-border syndicated lending by 75 banks to 59 countries. We find that banks that had to write down sub-prime assets, refinance large amounts of long-term debt, and experienced sharp declines in their market-to-book ratio, transmitted these shocks across borders by curtailing their lending abroad. While shocked banks differentiated among countries in much the same way as less constrained banks, they restricted their lending more to small borrowers.
    Keywords: Crisis transmission, cross-border lending, syndicated loans
    JEL: F36 F42 F52 G15 G21 G28
    Date: 2012–01

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