Are Capital Inflows Expansionary or Contractionary? Theory, Policy Implications, and Some Evidence
IMF Working Papers, October 23, 2015
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- Are Capital Inflows Expansionary or Contractionary? Theory, Policy Implications, and Some Evidence
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Bibliographic details
- Authors: Olivier J Blanchard, Jonathan David Ostry, Atish R. Ghosh, Marcos Chamon
- Published: October 23, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513500805.001
Summary / Core argument
- The workhorse open-economy macro model suggests that capital inflows are contractionary because they appreciate the currency and reduce net exports.
- Emerging market policy makers believe that inflows lead to credit booms and rising output, and the evidence appears to go their way.
- To reconcile theory and reality, the paper extends the set of assets included in the Mundell-Fleming model to include both bonds and non-bonds.
- At a given policy rate, inflows may decrease the rate on non-bonds, reducing the cost of financial intermediation, potentially offsetting the contractionary impact of appreciation.
- The authors explore the implications theoretically and empirically, and find support for the key predictions in the data.
Theoretical framework
- Extension of the Mundell-Fleming model to include both bonds and non-bonds.
- Mechanism: capital inflows → lower rate on non-bonds (at a given policy rate) → reduced cost of financial intermediation → possible expansionary effects that can offset currency appreciation and export contraction.
Empirical evidence / Findings
- The paper reports empirical support for the key model predictions that inflows can be associated with credit booms and rising output via effects on non-bond rates and financial intermediation.
- Observed tension between standard open-economy prediction (contractionary inflows via appreciation and reduced net exports) and emerging market experience (inflows associated with credit and output expansion) is addressed and reconciled by the model and evidence presented.
Policy implications and interpretation
- Recognizing distinct asset types (bonds vs. non-bonds) and their differential interest-rate dynamics is important for assessing the macroeconomic effects of capital inflows.
- Policy analysis should account for the possibility that inflows can lower non-bond rates and stimulate credit, which may offset traditional contractionary channels.
- Implicitly suggests that tools focusing only on exchange-rate or bond-market channels may miss important non-bond/intermediation effects of inflows.
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- _wp15226 - Conclusions