Payment Frictions, Capital Flows, and Exchange Rates
IMF Working Papers, August 29, 2025
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- Payment Frictions, Capital Flows, and Exchange Rates
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Bibliographic details
- Authors: Marco Reuter, Itai Agur, Alexander Copestake, Maria Soledad Martinez Peria, Ken Teoh
- Published: August 29, 2025
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798229022521.001
Summary
- Cross-border payments are changing: existing intermediaries are upgrading their networks and new platforms based on novel digital forms of money are being explored, even as geoeconomic fragmentation is introducing new frictions.
- The authors develop a stylized model to assess implications for the level and volatility of capital flows and exchange rates.
- Key headline results:
- On levels, lower frictions in cross-border payments reduce UIP deviations and increase capital flows.
- On volatility, the impact of lower frictions depends on the type of shock and the degree to which frictions decline.
Findings on levels
- Lower frictions in cross-border payments:
- Reduce UIP (Uncovered Interest Parity) deviations.
- Increase capital flows.
Findings on volatility
- For real shocks:
- Lower frictions increase capital flow volatility.
- Lower frictions reduce exchange rate volatility.
- For financial shocks:
- Lower frictions increase exchange rate volatility.
- The impact on capital flow volatility is ambiguous:
- When frictions decline by a small amount, capital flow volatility increases.
- When the reduction in frictions is large, capital flow volatility decreases.
- An increase in frictions reverses these results.
Model and scenarios
- Approach:
- A stylized model is used to isolate how changes in cross-border payment frictions affect UIP deviations, capital flows, and exchange rate behavior.
- Comparative scenarios considered:
- Small declines in payment frictions.
- Large declines in payment frictions.
- Increases in payment frictions.
- Response heterogeneity:
- Outcomes differ by shock type (real versus financial) and by the magnitude of the friction change.
Relevant subjects and keywords (as presented)
- Subject: Balance of payments, Capital account, Capital flows, Current account, Exchange rates, Financial services, Foreign exchange, Interest rate parity
- Keywords: Capital account, Capital Flows, Current account, Exchange Rates, fixed cost, frictions decline, frictions increase exchange rate volatility, Global, IMF working paper research Department, Interest Parity, Interest rate parity, payment friction, Payment Frictions
IMF Working Paper No. 2025/171, August 29, 2025.
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