Working Paper: NBER ID: w23975
Authors: Graciela L. Kaminsky
Abstract: A common belief in both academic and policy circles is that cyclical monetary policy in the United States increases the volatility of capital flows to the periphery. More recently, many studies on capital flows also focus on the U.S. Subprime Crisis. These studies emphasize the excessive international borrowing predating that crisis and the dramatic global retrenchment in capital flows in its aftermath. I re-examine these views using a new database I constructed of capital flows spanning two hundred years. Extending the study of capital flows to the first episode of financial globalization has two major advantages. First, during this episode, monetary policy in the financial center is constrained by the adherence to the Gold Standard, thus providing a benchmark for capital flow cycles in the absence of an active role of the central bank in the financial center. Second, panics in the financial center are rare disasters that need to be examined in a longer historical episode. The evidence from the new database indicates that capital flows to the periphery have become less volatile since the restart of globalization in the 1970s. But not all cycles are less pronounced, only those cycles around panics in the financial center. It is in times of crises at the epicenter that countercyclical monetary policy in the financial center is far more aggressive, with severe tightenings predating these crises and drastic easings in their aftermath. This policy cuts short capital flow bonanzas before these crises erupt and mitigates sudden stops in their aftermath.
Keywords: international capital flows; monetary policy; financial globalization; Latin America; borrowing cycles
JEL Codes: F30; F34; F65
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Cyclical monetary policy in the U.S. (E52) | Volatility of capital flows to the periphery (F32) |
| Aggressive counter-cyclical monetary policies (E63) | Mitigation of capital flow bonanzas before crises (F32) |
| Aggressive counter-cyclical monetary policies (E63) | Easier access to liquidity during busts (E44) |
| Capital flow bonanzas preceding financial center crises (F65) | Size of capital flow bonanzas (F32) |
| Busts following financial center crises (G01) | Size of busts (C29) |
| Changes in monetary regimes (E42) | Time-varying characteristics of international capital flow cycles (F32) |