Working Paper: NBER ID: w21619
Authors: Olivier Blanchard; Jonathan D. Ostry; Atish R. Ghosh; Marcos Chamon
Abstract: The workhorse open-economy macro model suggests that capital inflows are contractionary because they appreciate the currency and reduce net exports. Emerging market policy makers however believe that inflows lead to credit booms and rising output, and the evidence appears to go their way. To reconcile theory and reality, we extend the set of assets included in the Mundell-Fleming model to include both bonds and non-bonds. At a given policy rate, inflows may decrease the rate on non-bonds, reducing the cost of financial intermediation, potentially offsetting the contractionary impact of appreciation. We explore the implications theoretically and empirically, and find support for the key predictions in the data.
Keywords: capital inflows; expansionary; contractionary; monetary policy; emerging markets
JEL Codes: F21; F23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bond inflows (F21) | currency appreciation (F31) |
| currency appreciation (F31) | contraction in net exports (F29) |
| contraction in net exports (F29) | contraction in output (E23) |
| nonbond inflows (F21) | currency appreciation (F31) |
| currency appreciation (F31) | decrease in rate of return on nonbonds (G12) |
| decrease in rate of return on nonbonds (G12) | lower cost of financial intermediation (G21) |
| lower cost of financial intermediation (G21) | increase in domestic demand (R22) |
| nonbond inflows (F21) | increase in output (E23) |
| bond inflows (F21) | contraction in output (E23) |
| exogenous movements in bond flows (F32) | negative effect on output (E23) |
| nonbond flows (F20) | significant positive effect on output (E23) |