Facing the Global Financial Cycle: What Role for Policy

IMF Working Papers, February 12, 2021

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The paper asks whether countries can influence their exposure to changes in global financial conditions.
Cross-country capital flows can be modeled via a global factor that closely tracks changes in global financial conditions.
There is a large degree of heterogeneity in the sensitivity of each country to the same global factor.
Main empirical results:
- Higher levels of capital controls dampen the sensitivity to the global factor.
- Higher levels of macroprudential policies dampen the sensitivity to the global factor.
- Countries’ monetary and exchange rate policies can also be successfully deployed to influence sensitivity to the global factor.
The results apply beyond the surge that preceded the 2008 global financial crisis and are relevant for the financial disruptions following the COVID-19 pandemic.

Capital flow management measures, including capital controls, can reduce a country’s sensitivity to global financial cycles.
Macroprudential policies are effective in dampening exposure to global financial conditions.
Monetary policy and exchange rate policy are additional tools that can be used to influence a country’s exposure to global financial shocks.
Policy mixes that combine capital flow measures, macroprudential tools, and monetary/exchange-rate strategies are implied by the findings to manage cross-border vulnerability to global financial conditions.

Subject: Capital controls, Capital flow surges, Capital flows, Capital inflows, Exchange rates
Keywords: capital flow data, capital flow episode happening, capital flow surge episode, capital flows shock, GFCy spillover, Global Financial Cycle, IMF Institutional View., Macroprudential Policy, surge episode, WP