Working Paper: NBER ID: w29615
Authors: Mitali Das; Gita Gopinath; Ebnem Kalemlizcan
Abstract: We show that “preemptive” capital flow management measures (CFM) can reduce emerging markets and developing countries' (EMDE) external finance premia during risk-off shocks, especially for vulnerable countries. Using a panel dataset of 56 EMDEs during 1996-2020 at monthly frequency, we document that countries with preemptive policies in place during the five year window before risk-off shocks experienced relatively lower external finance premia and exchange rate volatility during the shock compared to countries which did not have such preemptive policies in place. We use the episodes of Taper Tantrum and COVID-19 as risk-off shocks. Our identification relies on a difference-in-differences methodology with country fixed effects where preemptive policies are ex-ante by construction and cannot be put in place as a response to the shock ex-post. We control the effects of other policies, such as monetary policy, foreign exchange interventions (FXI), easing of inflow CFMs and tightening of outflow CFMs that are used in response to the risk-off shocks. By reducing the impact of risk-off shocks on countries' funding costs and exchange rate volatility, preemptive policies enable countries' continued access to international capital markets during troubled times.
Keywords: capital flow management; risk-off shocks; emerging markets; external finance premia
JEL Codes: F3; F31; F41; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Preemptive capital flow management measures (F32) | Uncovered interest parity (UIP) risk premium (F31) |
| Preemptive capital flow management measures (F32) | Exchange rate volatility (F31) |
| Uncovered interest parity (UIP) risk premium (F31) | Default risk on local currency debt (F34) |
| Preemptive capital flow management measures (F32) | Foreign exchange (FX) debt levels (F31) |