Global Imbalances and Foreign Asset Expansion by Developing Economy Central Banks

Abstract

Over the past 10 years, central banks and governments throughout the developing world have accumulated foreign exchange reserves and other official assets at an unprecedented rate. This paper shows that this official asset accumulation has driven a substantial portion of the recent large global current account imbalances. These net official capital flows have become large relative to the size of the industrial economies, and they are a significant factor contributing to the weakness of the economic recovery in the major industrial economies. JEL Codes: F30, F31, F32

Official Financial Flows, Capital Mobility, and Global Imbalances

“…Bayoumi and Saborowski (2014), Gagnon (2012), and IMF (2012 augment the Chinn and Prasad framework to include reserve accumulation or net official financial flows as a measure of a government's exchange rate policy. 1 All five studies find a significant effect of net official flows on the current account balance.…”

“…The coefficient γ represents the direct effect of capital mobility on the current account, if any. The regressions include a standard set of controls for other potential determinants of the current account similar to those used in Gagnon (2012Gagnon ( , 2013 and Bayoumi and Saborowski (2014). 18 Equation (3) is a restatement of the link between official flows and the current account in equation (2) that takes advantage of the BOP identity: Any effect of net official flows on the current account that is less than 1 must show up as a negative effect on net private flows.…”

“…On the other hand, examples of exogenous movements in official flows include increasing holdings of foreign assets for precautionary reasons, saving resource revenues for future generations, borrowing for economic development, and achieving economic growth through higher net exports. Gagnon (2012Gagnon ( , 2013 shows that endogeneity through stabilization of the exchange rate leads to a positive bias of the coefficient on net official flows if current account shocks dominate and a negative bias if private financial shocks dominate. Conventional wisdom suggests that financial shocks are important; witness the complaints from central banks in emerging markets about private capital flows driven by monetary policy in advanced economies.…”

“…Valid instruments must reflect exogenous motives for reserve accumulation. Gagnon (2012Gagnon ( , 2013 and Bayoumi and Saborowski (2014) used sets of instruments that include country dummies interacted with the lagged ratio of gross official assets to imports of goods and services as instruments. Months of import cover is a common metric for adequacy of foreign exchange reserves.…”

Unconventional Monetary and Exchange Rate Policies

“…On the other hand, examples of exogenous movements in official flows include increasing holdings of foreign assets for precautionary reasons, saving resource revenues for future generations, borrowing for economic development, and achieving economic growth through higher net exports. Gagnon (2012Gagnon ( , 2013 shows that endogeneity through stabilization of the exchange rate leads to a positive bias of the coefficient on NOF if current account shocks dominate, and a negative bias if private financial shocks dominate.…”