Preemptive Policies and Risk-Off Shocks in Emerging Markets

By Mitali Das, Gita Gopinath, Sebnem Kalemli-Ozcan

January 7, 2022

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Mitali Das, Gita Gopinath, and Sebnem Kalemli-Ozcan. Preemptive Policies and Risk-Off Shocks in Emerging Markets, (USA: International Monetary Fund, 2022) accessed November 8, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We show that “preemptive” capital flow management measures (CFM) can reduce emerging markets and developing countries’ (EMDE) external finance premia during risk-off shocks, especially for vulnerable countries. Using a panel dataset of 56 EMDEs during 1996–2020 at monthly frequency, we document that countries with preemptive policies in place during the five year window before risk-off shocks experienced relatively lower external finance premia and exchange rate volatility during the shock compared to countries which did not have such preemptive policies in place. We use the episodes of Taper Tantrum and COVID-19 as risk-off shocks. Our identification relies on a difference-in-differences methodology with country fixed effects where preemptive policies are ex-ante by construction and cannot be put in place as a response to the shock ex-post. We control the effects of other policies, such as monetary policy, foreign exchange interventions (FXI), easing of inflow CFMs and tightening of outflow CFMs that are used in response to the risk-off shocks. By reducing the impact of risk-off shocks on countries’ funding costs and exchange rate volatility, preemptive policies enable countries’ continued access to international capital markets during troubled times.

Subject: Balance of payments, Capital flow management, Capital inflows, Financial sector policy and analysis, Financial services, Foreign exchange, Interest rate parity, Macroprudential policy instruments

Keywords: Africa, Capital flow management, Capital inflows, Exchange rate volatility, External finance premia, FX debt, Global, Interest rate parity, Macroprudential policy instruments, MPM policy, Preemptive policies, Risk-off shock, Risk-Off shock, Risk-off shocks, UIP

Publication Details

Pages:

54
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2022/003
Stock No:

WPIEA2022003
ISBN:

9781616358341
ISSN:

1018-5941

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