I organized the International Economics and Finance Society panel on “Financial Integration and Global Rebalancing” at the
Allied Social Sciences Association meetings in Chicago. In the end, the papers fit together much better than I had anticipated; they all dealt with with the factors driving the puzzling pattern of current account balances — and how policy can possibly influence those patterns.
The first paper, Bubble Thy Neighbor: Direct and Spillover Effects of Capital Controls, written by Kristin Forbes (Massachusetts Institute of Technology), Marcel Fratzscher (European Central Bank),
Thomas Kostka (European Central Bank), and Roland Straub (European Central Bank). From the abstract:
We use changes in Brazil’s tax on foreign investors from 2006 to 2011 to test for any direct and multilateral effects of capital controls on portfolio flows. The analysis is structured based on information from a series of investor interviews. We find that increases in Brazil’s capital controls cause investors to decrease their portfolio allocations to Brazil. Investors simultaneously decrease portfolio allocations to other countries believed to be more likely to use controls, and increase allocations to other countries in Latin America, that constitute a large share of the benchmark index, and that have substantial exposure to China. The results suggest that much of the effect of capital controls on portfolio flows is through signalling rather than the direct cost of the controls. The results also suggest that any assessment of capital controls should consider their spillover effects on investment in other countries.
The motivation for the study is clearly laid out in the introduction:
Economists and policymakers have recently become more supportive of capital controls, especially controls on capital inflows, to limit the appreciation of overvalued currencies and reduce financial fragilities resulting from large and volatile capital flows. This support has been bolstered by the empirical literature on the macroeconomic effects of capital controls. Although there are some differences across individual papers, surveys generally conclude that controls on capital inflows have no significant effect on the volume of capital inflows, but can shift the composition of capital flows to reduce country vulnerability.
But what if, as many policymakers currently believe, controls on capital inflows can significantly reduce the volume of certain types of capital flows into a country? For example, the finance minister of Brazil, Guido Mantega, stated: “We took tough measures … and we succeeded in stemming the flow [of capital inflows].” Since this literature generally finds little effect of controls on total capital inflows, there was little concern about the spillover effects of capital controls on capital flows to other countries. And if capital controls affect flows into one country, what are the multilateral effects? Do controls simply shift the challenges of large capital inflows—such as asset bubbles and currency appreciation—from one country to another? If so, which countries are most affected? These types of externalities could be particularly important in the current environment of large global imbalances in which macroeconomic policies in some countries are already distorting capital flows in ways that foster fragilities and could create future challenges (e.g., Rajan, 2010).
In her discussion, Helen Popper (Santa Clara University) highlighted several issues, but her key concern was with the issue of endogeneity. In her example, QE2 induces incipient capital controls in several emerging markets. The pattern of resulting flows is not due to capital control spillovers.
The second paper, Sovereigns, Upstream Capital Flows, and Global Imbalances, written by
Laura Alfaro (Harvard University), Sebnem Kalemli-Ozcan (University of Houston),
and Vadym Volosovych (Erasmus University Rotterdam), provided a resolution to one of the key puzzles in international finance — the tendency for capital to flow from poor countries to rich countries.
The paper presents new stylized facts on the direction of capital flows. We find (i) international capital flows net of government debt and/or official aid are positively correlated with growth; (ii) sovereign debt flows are negatively correlated with growth only if debt is financed by another sovereign; (iii) public savings are robustly positively correlated with growth as opposed to private savings. Sovereign to sovereign transactions can fully account for upstream capital flows and global imbalances. These empirical facts contradict the conventional wisdom and constitute
a challenge for existing theories.
Joe Gagnon‘s paper, “Global Imbalances and Foreign Asset Expansion by Developing-Economy Central Banks” [presentation] made the following
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.
[link to paper added, abstract edited, 1/10, 11:11AM PST]
The basic point is that over the last ten years, each one percentage point of GDP of official outflows (reserve accumulation) is associated with a 0.7 percentage point increase in the current account. (The regression uses a ten year average, and weights observations by GDP). Figure 2 from the paper illustrates this assertion.
Figure 2 from Gagnon (2012).
The discussant, Steven Kamin (Federal Reserve Board), found the analysis persuasive, but was not wholely convinced. In particular, he was concerned with endogeneity issues under fixed exchange rates. For instance, shocks to the current account balance inducing exchange rate appreciation could induce responses in official capital outflows.
The final paper was The Persistence and Determinants of Current Account Balances: The Implications for Global Rebalancing, written by
Erica Clower (University of Washington) and Hiro Ito (Portland State University). From the abstract:
This paper examines the dynamics of current account balances with particular focus on the statistical nature of the persistency of current account balances and its determinants.
With the assumption that stationary current account series ensures the long-run budget constraint while countries may experience “local nonstationarity” in current account balances, we examine the dynamics of current account balances across a panel of 70 countries. While linear unit root tests fail to reject the null hypothesis of a unit root for a number of countries, a Markov-switching (MS)-ADF econometric framework that allows for regime switches in current account dynamics not only lead us to reject the unit root null hypothesis for a much increased number of countries, but also provide notable cross country differences in the timing and duration of stationary and locally nonstationary regimes. Armed with the structural break dates the MS-ADF testing provides, we investigate the determinants of the different degrees of current account persistence. We find that the lack of trade openness, net foreign assets, and financial development help increase the degree of current account persistence. The type of exchange rate regimes is not found to be a robust determinant of current account persistence, but fixed exchange rate regime is more likely to lead an emerging market country to enter nonstationary current account regime.
Atish Ghosh (International Monetary Fund) discussed the paper. He conjectured that the failure to find importance for the exchange rate regime was due to misclassification of the euro area countries as being on a floating regime — when in fact the individual countries of the euro area could be thought to be in a fixed regime. (He also discusses the related Chinn-Wei results regarding CA persistence [paper].)