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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
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
Technical progress (the most
important factor)
Lowering transaction costs
Increasing capital mobility
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
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.
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
7
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
Consequences for
macroeconomic policy making
• Capital mobility and balance-of-
payment management
• Capital mobility and monetary policy
8
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’
9
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
10
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
11
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)
12
13
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)
CEE: capital vs. current account
14
-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
LAC: capital vs. current account
15
-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
16
-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
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
17
18
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)
19
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)
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;
20