{
  "title": "Are Capital Flows Expansionary or Contractionary? It Depends What Kind",
  "publication": "IMF Blog, December 7, 2015",
  "sourceUrl": "https://www.imf.org/en/blogs/articles/2015/12/07/are-capital-flows-expansionary-or-contractionary-it-depends-what-kind",
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  "summary": "Authors: Olivier Blanchard, Jonathan D. Ostry, Marcos Chamon, Atish Rex Ghosh",
  "sections": [
    {
      "heading": "Overview",
      "content": "- Authors: Olivier Blanchard, Jonathan D. Ostry, Marcos Chamon, Atish Rex Ghosh\n- Date: December 7, 2015\n- Central question: Do capital inflows generally expand or contract economic activity in emerging markets?\n- Key empirical observation motivating the analysis: In typical emerging-market cases, capital inflows appear to be associated with currency appreciations, credit booms, and output increases (Ostry et al., 2012a)."
    },
    {
      "heading": "Theoretical reconciliation: bonds vs. non-bonds",
      "content": "- Standard model implication:\n  - Mundell-Fleming model suggests that, for a given monetary policy rate, inflows lead to an appreciation and thus to a contraction in net exports and a decrease in output.\n  - Paul Krugman (2013) used a related model to argue that capital outflows are expansionary.\n- Extended-asset framework offered by the authors:\n  - Distinguishes between “bonds” (policy-rate-type assets) and “non-bonds” (equities, bank liabilities—imperfect substitutes for bonds).\n  - Capital inflows can lower the rate on non-bonds even if the policy rate is unchanged, reducing the cost of financial intermediation.\n  - The positive domestic-demand effects from lower non-bond rates can offset adverse effects from currency appreciation.\n  - Conclusion: Capital inflows may be expansionary even for a given policy rate; this reconciles the Mundell-Fleming intuition with policymakers’ observations."
    },
    {
      "heading": "Role of foreign exchange market intervention",
      "content": "- Sterilized FX intervention through bonds:\n  - Can fully offset the effects of bond inflows, leaving both the exchange rate and interest rates unchanged.\n  - Mechanism: central bank takes opposite position to foreigners—reduces demand for domestic bonds and increases holdings of foreign assets when foreigners increase demand for domestic bonds.\n- Sterilized intervention in response to non-bond inflows:\n  - Can avoid currency appreciation, but only at the cost of a larger decrease in the rate of return on non-bonds (see Blanchard et al., 2015)."
    },
    {
      "heading": "Capital controls",
      "content": "- Targeted capital controls alter the mix and effects of inflows:\n  - Controls on bond inflows:\n    - Reduce bond inflows.\n    - Increase the effects of non-bond inflows on the exchange rate and on the rate of return on non-bonds.\n  - Controls on non-bond inflows:\n    - Magnify the effect of bond inflows on the exchange rate.\n- In both cases:\n  - Targeted capital controls reduce upward pressure on the currency, which increases the “spillover” effects from the non-targeted inflow on the exchange rate, the rate of return, or both."
    },
    {
      "heading": "Effects of monetary policy and the “policy dilemma”",
      "content": "- Central bank objective choices (besides output/inflation mandate):\n  - Stabilize the exchange rate → will lower the policy rate.\n  - Stabilize the rate of return on non-bonds (limit credit expansion) → will increase the policy rate.\n- Policy dilemma framed:\n  - Trade-off between stabilizing the exchange rate and limiting declines in non-bond returns.\n- False dilemma:\n  - A combination of instruments (monetary policy + FX intervention) can, in principle, offset the effects of inflows on both the exchange rate and the rate of return to non-bonds without capital controls (see Ostry et al., 2012b).\n  - This offers a more optimistic view than Rey (2013), who argued that, short of macroprudential tools or capital controls, countries cannot divorce themselves from global financial flows."
    },
    {
      "heading": "Empirical evidence",
      "content": "- Identification challenge:\n  - Theoretical arguments concern effects of exogenous capital flows; empirical work requires instruments that affect inflows but are plausibly exogenous to domestic events.\n  - Empirical analysis must control for countries’ policy tool usage that may offset flow effects.\n- Main empirical findings:\n  - Bond inflows have a negative effect on economic activity.\n  - Non-bond inflows have a significant and positive effect on economic activity.\n  - Non-bond inflows (excluding FDI) have a strong positive effect on credit, much stronger than bond flows—highlighting the credit channel as key to output effects."
    },
    {
      "heading": "Policy implications",
      "content": "- Different nature of inflows requires different policy mixes:\n  - Bond inflows: more likely contractionary for a given policy rate; sterilized intervention via bonds can neutralize effects on exchange rate and interest rates.\n  - Non-bond inflows: can be expansionary by lowering non-bond rates and stimulating credit; sterilized intervention can prevent appreciation but may further depress non-bond returns.\n  - Targeted capital controls change the relative pressures from different inflows and can amplify spillovers from the non-targeted inflow type.\n  - Combining instruments—monetary policy, FX intervention, and, where appropriate, capital controls or macroprudential measures—allows policymakers to manage exchange-rate and credit-return trade-offs without accepting a strict dilemma.\n\nSource: IMF blog post \"Are Capital Flows Expansionary or Contractionary? It Depends What Kind\" (December 7, 2015).\n\n---\n\n Content in this bundle\n\n- 14th Jacques Polak Annual Research Conference; November 7–8, 2013\n  - 14th Jacques Polak Annual Research Conference; November 7–8, 2013 (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - 14th Jacques Polak Annual Research Conference; November 7–8, 2013 (PDF){rel=\"external\" type=\"application/pdf\"}\n- Staff Discussion Note\n  - Staff Discussion Note (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Staff Discussion Note (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\n References\n\n- recent work\n\nSource: https://www.imf.org/en/blogs/articles/2015/12/07/are-capital-flows-expansionary-or-contractionary-it-depends-what-kind"
    }
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    "Authors: Olivier Blanchard, Jonathan D Ostry, Marcos Chamon, Atish Rex Ghosh",
    "Published: December 7, 2015",
    "Authors: Olivier Blanchard, Jonathan D. Ostry, Marcos Chamon, Atish Rex Ghosh",
    "Date: December 7, 2015",
    "Central question: Do capital inflows generally expand or contract economic activity in emerging markets?",
    "Key empirical observation motivating the analysis: In typical emerging-market cases, capital inflows appear to be associated with currency appreciations, credit booms, and output increases (Ostry et al., 2012a).",
    "Standard model implication:",
    "Extended-asset framework offered by the authors:",
    "Sterilized FX intervention through bonds:",
    "Sterilized intervention in response to non-bond inflows:",
    "Targeted capital controls alter the mix and effects of inflows:",
    "In both cases:",
    "Central bank objective choices (besides output/inflation mandate):",
    "Policy dilemma framed:",
    "False dilemma:",
    "Identification challenge:",
    "Main empirical findings:",
    "Different nature of inflows requires different policy mixes:",
    "**14th Jacques Polak Annual Research Conference; November 7–8, 2013**",
    "**Staff Discussion Note**",
    "[recent work](http://www.imf.org/external/pubs/cat/longres.aspx?sk=43360.0)"
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