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Marek Dabrowski Managing capital flows in a globalized economy Presentation at the Course on Integration in Europe: European Union and Eurasian Union, Joint Vienna Institute, Vienna, October 23, 2014

Managing capital flows in a globalized economy_Marek Dabrowski

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Page 1: Managing capital flows in a globalized economy_Marek Dabrowski

Marek Dabrowski

Managing capital flows in

a globalized economy

Presentation at the Course on “Integration in Europe: European

Union and Eurasian Union”, Joint Vienna Institute,

Vienna, October 23, 2014

Page 2: Managing capital flows in a globalized economy_Marek Dabrowski

Increasing integration of financial markets:

• development of world trade

• a progressing capital account liberalization;

• liberalization of the banking sector and other segments

of financial market;

• transnational expansion of the large banks from

developed countries;

• privatization of banks and other financial institutions in

emerging-market and developing economies;

• technical progress in ICT;

• increasing level of general and economic education

Page 3: Managing capital flows in a globalized economy_Marek Dabrowski

Technical progress (the most

important factor)

Lowering transaction costs

Increasing capital mobility

Page 4: Managing capital flows in a globalized economy_Marek Dabrowski

Arguments in favor of full

capital account liberalization:

• Import/ export of savings (saving-investment imbalance)

• Better resource allocation

• Deepening financial market and its disciplining role

• Difficulties in separating ‘good’ and ‘bad’ flows

• Technical difficulties in effective capital control

• Reputation problems

• Limiting room for bad policies

• EU accession requirements in the case of CEE countries

Page 5: Managing capital flows in a globalized economy_Marek Dabrowski

Arguments against full capital

account liberalization

• Greater external vulnerability (exposure to

various shocks)

• Fragile macroeconomic foundations (high

inflation, high fiscal deficit, etc.)

• Limited microeconomic absorption (weak

banking and corporate sectors)

• Regulatory problems, etc.

Page 6: Managing capital flows in a globalized economy_Marek Dabrowski

The balance of pros and cons

• If country is already advanced in capital

account liberalization keeping or

coming back to capital control is not a

good proposal

• If country only starts opening up their

capital accounts there is issue of proper

sequencing

Page 7: Managing capital flows in a globalized economy_Marek Dabrowski

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CountryExchange restrictions and Multiple Currency

Practices (MCP)

Control for payments on

invisible transactions and

current transfers

Controls on proceeds

from exports/ invisible

transactions

Capital

controls

Armenia no no residual

Azerbaijan yes yes partial

Belarus temporary in 2011 (including MCP) yes yes far-going

Georgia yes partial residual

Kazakhstan yes partial partial+

Kyrgyzstan no no partial

Moldova yes partial far-going

Russia no partial partial

Tajikistan yes partial far-going

TurkmenistanArticle XIV (only 19 countries), numerous

restrictions on current transactionsyes yes far-going

Ukrainetemporary between Oct 2008 and May 2010

(including MCP); again since the end of 2013yes yes far-going

Uzbekistannumerous restrictions on current transactions and

MCPyes yes far-going

CIS: Exchange Arrangements and Regulatory Frameworks for

Current and Capital Transactions (as of 31.12.2011)

Source: Annual Report on Exchange Arrangements and Exchange Restrictions, IMF, October 2012, Table 9 and "Summary Features", pp.71-79, and

Author’ s assessment

Page 8: Managing capital flows in a globalized economy_Marek Dabrowski

Consequences for

macroeconomic policy making

• Capital mobility and balance-of-

payment management

• Capital mobility and monetary policy

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Page 9: Managing capital flows in a globalized economy_Marek Dabrowski

BoP analysis: traditional assumptions

• BoP and IIP are concepts based on residency;

capital has its fixed residency (domicile)

• individual country gross national investment must

be ultimately financed out of this country gross

national saving (even if inter-temporal balance-of-

payments imbalances are accepted) - echo of the

Feldstein-Horioka (1980) ‘home country bias’

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Page 10: Managing capital flows in a globalized economy_Marek Dabrowski

BoP analysis: policy implications of

traditional assumptions

Net capital inflow leads to accumulation of

country’s external liabilities, which

• cannot grow indefinitely,

• must be repaid at some point,

• higher they are, more vulnerable country’s

external position is

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Page 11: Managing capital flows in a globalized economy_Marek Dabrowski

BoP analysis: the alternative set of

assumptions

• unrestricted cross-border capital mobility

• major sources of capital do not have country of

origin (may change their domicile)

• private investors seek the highest rate of return

disregarding country borders

• some countries may offer higher rate of return

than others for a long period of time

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Page 12: Managing capital flows in a globalized economy_Marek Dabrowski

BoP analysis: consequences of modified

assumptions

• Country may become capital exporter or capital importer for a long period of time

• The expected rate of return determines the direction of capital movement

• In the case of capital outflow it also affects residents

• But current account imbalances still matter as long as country has its own currency (exchange rate risk)

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Page 13: Managing capital flows in a globalized economy_Marek Dabrowski

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Current account vs. capital account

• Traditional approach (in the world of restricted capital mobility): domestic factors of competitiveness + trade policy + exchange rate policy trade and current account balance capital flows

• The reverse causality in the world of free capital mobility: net capital flows have exogenous character and current account balance adapts to changes in capital account (through changes in real exchange rates)

• Policy consequences: national macroeconomic policy has limited control over current account balance and real exchange rate (even if it controls nominal exchange rate)

• Criteria of assessment of current account: who is doing well, who is vulnerable (doubts in respect to the EU’s Excessive Imbalance Procedure or idea of current account targeting within the G20)

Page 14: Managing capital flows in a globalized economy_Marek Dabrowski

CEE: capital vs. current account

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-200

-150

-100

-50

0

50

100

150

200

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

US

D b

illi

on

net private capital flows

current account balance

Page 15: Managing capital flows in a globalized economy_Marek Dabrowski

LAC: capital vs. current account

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-100

-50

0

50

100

150

200

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

US

D b

illi

on

net private capital flows

current account balance

Page 16: Managing capital flows in a globalized economy_Marek Dabrowski

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-100

-50

0

50

100

150

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

US

D b

illi

on

net private capital flows

current account balance

CIS: capital vs. current account

Page 17: Managing capital flows in a globalized economy_Marek Dabrowski

Can countries influence the size and

direction of capital flows?

• Capital controls – unavailable for EU members, doubtful

effectiveness in other cases

• Monetary policy (no impact under hard peg, limited impact under

flexible exchange rate)

• Fiscal policy (macro): some impact

• Fiscal incentives (micro): some impact (more in respect to structure

of capital flows than volume)

• Macro-prudential regulation: depending what does it mean in

practice (some impact)

• Micro-prudential regulation: see fiscal incentives

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Page 18: Managing capital flows in a globalized economy_Marek Dabrowski

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Capital mobility and monetary policy

(national perspective)

• Domestic money supply is largely exogenous as result of unrestricted capital flows.

• Even under the free floating exchange rate and inflation targeting limited room of maneuver (interest rate decisions must take into account international financial market trends, limits of currency appreciation/ depreciation).

• Consequences of monetary policies of major central banks (especially the US Fed) far beyond their formal jurisdictions major source of actual volatility in capital flows, export of inflation or deflation

• Others must follow decisions of major players (dealing with ‘external’ shocks produced by their decisions)

Page 19: Managing capital flows in a globalized economy_Marek Dabrowski

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Capital mobility and monetary policy

(global perspective)

• Call for global monetary policy coordination – how much politically realistic???

• Worse, macroeconomic theory does not provide conceptual and analytical tools for such a coordination – How to define and measure a global money supply?

– What factors and mechanisms determine changes in global money supply? (for example, the role of cross-country money multipliers under various exchange rate regimes)

– All theoretical models of monetary policy (like the Taylor rule) analyze its determinants, tools and consequences within a single national economy (no global monetary model or even sufficient external spillovers in national models)

Page 20: Managing capital flows in a globalized economy_Marek Dabrowski

Recommended literature

• Dabrowski M. (2013): Managing capital flows in a globalized

economy, in: Nowotny, E., Mooslechner, E. & Ritzberger-

Gruenwald, D. (eds.): A New Model for Balanced Growth and

Convergence. Achieving Economic Sustainability in CESEE

Countries, National Bank of Austria & Edward Elgar

• Dabrowski M. (2013): Monetary policy regimes in CIS

economies and their ability to provide price and financial

stability, BOFIT Discussion Papers, No. 8/2013, Bank of

Finland, Institute for Economies in Transition,

http://www.suomenpankki.fi/bofit_en/tutkimus/tutkimusjulkaisut

/dp/Documents/2013/dp0813.pdf;

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