October 10, 2007
IMF World Economic Outlook on Managing Large Capital Inflows
The IMF has just released several chapters of its semi-annual World Economic Outlook. One chapter is entitled "Managing Large Capital Inflows".
Figure 3.1 from IMF, World Economic Outlook, Chapter 3.
The chapter observes:
...109 episodes of large net private capital inflows since 1987 were identified; 87 of these were completed by 2006. These episodes show several interesting patterns, broadly in line with the stylized facts discussed above:
- The incidence of episodes over time mirrors trends in net private capital inflows to emerging markets, with two waves of episodes of large capital inflows to emerging markets since the late 1980s—one in the mid-1990s and the recent one, starting in 2002 (Figure 3. , upper panel).
- Episodes completed during the first wave (between 1987 and 1998) generally involved a smaller volume of flows relative to GDP, especially compared with episodes that are ongoing; but they lasted longer than those that ended between 1999 and 2006 (Table 3.1).
- Emerging Asian and Latin American countries dominated the first wave of episodes, whereas the more recent episodes have been concentrated more in emerging Europe and other emerging market countries (Figure 3. , middle panel).
- More than one-third of the completed episodes ended with a sudden stop or a currency crisis (see Table 3.1), suggesting that abrupt endings are not a rare phenomenon.12
- Late and ongoing episodes are characterized by larger FDI flows, relative to the episodes completed in the 1990s (Figure 3. , lower panel).
Table 3.1 shows the summary statistics pertaining to these inflow episodes. It also tabulates the number of ongoing episodes -- the average duration of which is 3 years. In other words, large capital inflows is not an issue of the past.
Table 3.1 from IMF, World Economic Outlook, Chapter 3.
Some characteristics of macro aggregates and prices before, during and after these episodes is illustrated in Figure 3.9.
Figure 3.9 from IMF, World Economic Outlook, Chapter 3.
The chapter notes that some dimensions of economic performance depend upon the characteristics of the inflow, but also the policy responses to the inflows. The effects of different policies on post- versus during-episode growth are identified by a reduced form regression approach, with the results summarized in Table 3.2.
Table 3.2 from IMF, World Economic Outlook, Chapter 3.
From the chapter:
Table 3.2 shows that countercyclical fiscal policy through expenditure restraint during episodes of large capital inflows is associated with a smaller post-inflow decline in GDP growth, even after controlling for other factors that may have had a role in this decline -- such as changes in the terms of trade, world output growth, and the real U.S. Federal funds rate. The regressions also present evidence indicating that greater resistance to exchange market pressures is associated with a sharper economic slowdown in the aftermath of the episodes.
I think the table has some interesting results, in addition to those highlighted. First, capital controls don't seem to have the anticipated effect (although of course, there is always the issue of endogeneity). Second, sterilization seems to have a negative (albeit non-significant) impact on post-episode growth. But by far, the most interesting result, from my perspective, is the fact that fiscal restraint in the face of large capital inflows promises better economic performance after the inflow episode, than fiscal profligacy. (It's a lesson that many policymakers -- not just in emerging markets -- might want to heed.)
Disclosure note: As noted in the acknowledgments to the chapter, I was a consultant on this project early in the process of statistical analysis.
Posted by Menzie Chinn at October 10, 2007 03:16 PMdigg this | reddit
But by far, the most interesting result, from my perspective, is the fact that fiscal restraint in the face of large capital inflows promises better economic performance after the inflow episode, than fiscal profligacy. (It's a lesson that many policymakers -- not just in emerging markets -- might want to heed.)
Could you help me flesh out what you mean here by fiscal restraint versus fiscal profligacy?
It appears that that the IMF is confirming that currency "rate wars" do exist but that they ultimately end in decline. It would be interesting to see if the boom justifies the bust.
Posted by: DickF at October 11, 2007 05:03 AM
DickF: Rapid growth in real government expenditure is profligacy. The absence of that is fiscal restraint, in this interpretation. I think that definition would put the U.S. post-2000 in the profligate category.
Posted by: Menzie Chinn at October 12, 2007 01:16 PM
Speaking of the IMF, I would like to alert you to the recent launching of the first IMF blog: the "Public Financial Management Blog" whose address is http://blog-pfm.imf.org.
the purpose of the blog is to disseminate IMF work on public financial management (PFM) but also to disseminate developments in the area of PFM in general.
Posted by: Michel LAZARE at October 14, 2007 11:14 AM
Thanks, Michel, we've added it to the blogroll.
Posted by: JDH at October 14, 2007 11:20 AM
Thanks Menzie. Got it.
Posted by: DickF at October 15, 2007 08:35 AM