Working Paper: NBER ID: w24152
Authors: Anton Korinek
Abstract: We show that capital flows to emerging market economies create externalities that differ by an order of magnitude depending on the state-contingent payoff profile of the flows. Those with pro-cyclical payoffs, such as foreign currency debt, generate substantial negative pecuniary externalities because they lead to large repayments and contractionary exchange rate depreciations during financial crises. Conversely, capital flows with an insurance component, such as FDI or equity, are largely benign. We construct an externality pricing kernel and use sufficient statistics and DSGE model simulations to quantify the externalities that materialized during past financial crises. We find stark differences depending on the payoff profile, justifying taxes of up to 3% for dollar debt but close to zero for FDI. These findings contrast with the existing literature, which has suggested that policymakers should focus on reducing over-borrowing rather than changing the composition of external liabilities.
Keywords: Capital Flows; Emerging Markets; Externalities; Financial Stability; Regulation
JEL Codes: E44; F38; F41; H23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital inflow (F21) | increased debt obligations (H63) |
| increased debt obligations (H63) | negative economic outcomes (F69) |
| capital flows with an insurance component (F32) | largely benign effects (I12) |
| optimal taxation on different types of capital flows (F38) | internalize externalities (D62) |
| type of capital flow (F32) | impact on economic stability (F65) |
| capital flows with pro-cyclical payoffs (F32) | substantial negative pecuniary externalities (D62) |