Working Paper: CEPR ID: DP14660
Authors: Fabio Ghironi; G Kemal Ozhan
Abstract: We study a novel policy tool—interest rate uncertainty—that can be used to discourage inefficient capital inflows and to adjust the composition of external accounts between short-term securities and foreign direct investment (FDI). We identify the trade-offs faced in navigating between external balance and price stability. The interest rate uncertainty policy discourages short-term inflows mainly through portfolio risk and precautionary saving channels. A markup channel generates net FDI inflows under imperfect exchange rate pass-through. We further investigate new channels under different assumptions about the irreversibility of FDI, the currency of export invoicing, risk aversion of outside agents, and effective lower bound in the rest of the world. Under every scenario, uncertainty policy is inflationary.
Keywords: international financial policy; stochastic volatility; short-term and long-term capital movements; unconventional monetary policy
JEL Codes: E32; F21; F32; F38; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Interest Rate Uncertainty (E43) | Short-Term Capital Inflows (F32) |
| Interest Rate Uncertainty (E43) | Portfolio Risk (G11) |
| Portfolio Risk (G11) | Short-Term Capital Inflows (F32) |
| Interest Rate Uncertainty (E43) | Precautionary Saving Behaviors (D14) |
| Interest Rate Uncertainty (E43) | Net FDI Inflows (F21) |
| Net FDI Inflows (F21) | Inflationary Pressures (E31) |
| Imperfect Exchange Rate Passthrough (F31) | Net FDI Inflows (F21) |
| Irreversibility of FDI (F21) | Net FDI Inflows (F21) |
| Currency of Export Invoicing (F31) | Net FDI Inflows (F21) |
| Risk Aversion of External Agents (D81) | Net FDI Inflows (F21) |