Has the unprecedented financial globalization of recent years changed the behavior of capital flows across countries? Using a newly constructed database of gross and net capital flows since 1980 for a sample of nearly 150 countries, this paper finds that private capital flows are typically volatile for all countries, advanced or emerging, across all points in time. This holds true across most types of flows, including bank, portfolio debt, and equity flows. Advanced economies enjoy a greater substitutability between types of inflows, and complementarity between gross inflows and outflows, than do emerging markets, which reduces the volatility of their total net inflows despite higher volatility of the components. Capital flows also exhibit low persistence, across all economies and across most types of flows. Inflows tend to rise temporarily when global financing conditions are relatively easy. These findings suggest that fickle capital flows are an unavoidable fact of life to which policymakers across all countries need to continue to manage and adapt. JEL Classification Numbers: F21, F32, O16
Risk sharing within a common currency area. Crosscountry risk sharing arrangements take on added importance in a common currency area. Within a currency union, countries cannot use monetary policy to respond to country-specific shocks, since the common monetary policy reflects the (weighted) fundamentals of all of the members and not that of any one country. Likewise, wage and price rigidities and limited labor mobility across countries, whether due to legal constraints like the immobility of pension benefits, or cultural factors, like language differences, can reduce the ability of a country to adjust to country-specific shocks. In principle, domestic fiscal policies are a natural tool in a currency union to manage country-specific shocks. But their scope to act counter-cyclically can sometimes be limited, as was seen in the euro area during the Great Recession: credit markets froze up, making it difficult both for sovereigns and private agents to use borrowing to smooth consumption. To some extent, liquidity provision by the European Central Bank and official crosscountry flows (through the TARGET2 settlement mechanism) helped fill the gap left by private credit markets (Cecchetti, McCauley, and McGuire, 2012). But crosscountry fiscal arrangements might be a powerful additional instrument to support risk sharing in these circumstances.
A failure to identify movements in the federal funds rate that are both unpredictable and independent of other determinants of open economy variables may lead to attenuation bias in the estimated effects of U.S. monetary policy on the exchange rate and foreign variables. Using a U.S. monetary policy measure which isolates unpredictable and independent federal funds rate changes, we quantify the magnitude of the attenuation bias for the exchange rate and foreign variables. The exchange rate appreciation following a monetary contraction is up to 4 times larger than a recursively-identified VAR estimate. There is stronger evidence of foreign interest rate pass-through. The expenditure-reducing effects of a U.S. monetary policy contraction dominate any expenditure-switching effects, leading to a positive conditional correlation of international outputs and prices. We compare our results with those obtained using identification based upon: (1) non-recursive VAR restrictions; and, (2) restrictions derived from high frequency asset price behavior.JEL Classification: E52, F31, F41
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