Working Paper: NBER ID: w21662
Authors: Joshua Aizenman; Mahir Binici
Abstract: We study the ways domestic and external global factors (such as risk appetite, global liquidity, U.S. monetary policy, and commodity prices) affected the exchange market pressure before and after the global financial crisis as well as the role of these factors during the Federal Reserve’s tapering episode. Utilizing a comprehensive database on capital controls, we investigate whether control measures have a significant impact on mitigating exchange market pressure associated with capital flows [net and gross]. Using quarterly data over the 2000–2014 period and a dynamic panel model estimation, we find that external factors played a significant role in driving exchange market pressure for both OECD countries and emerging market countries, with a larger impact on the latter. While the effect of net capital flows on exchange market pressure is muted, short-term gross portfolio inflows and outflows comprise important factors that account for exchange market pressure. Short-term portfolio flows and long-term foreign direct investment flows have a significant impact on exchange market pressure for emerging market economies and no significant effect for OECD countries. Capital controls seem to significantly reduce the exchange market pressure although the economic size of this impact is highly dependent on the institutional quality.
Keywords: Exchange Market Pressure; Capital Flows; Capital Controls; Dynamic Panel Model
JEL Codes: F3; F31; F33; F38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| net capital flows (F32) | exchange market pressure (EMP) (F31) |
| institutional quality (L15) | effectiveness of capital controls (F38) |
| global liquidity (F65) | exchange market pressure (EMP) (F31) |
| US monetary policy (E52) | exchange market pressure (EMP) (F31) |
| risk appetite (D81) | exchange market pressure (EMP) (F31) |
| short-term gross portfolio inflows (F32) | exchange market pressure (EMP) (F31) |
| short-term gross portfolio outflows (F32) | exchange market pressure (EMP) (F31) |
| capital controls (F38) | exchange market pressure (EMP) (F31) |