Growth from international capital flows: The role of volatility regimes
Ashoka Mody, Antu Panini Murshid 27 November 2011
Recent commentary has suggested that capital inflows – long considered a positive for growth – may actually be doing more harm than good. This column presents new evidence reinforcing the conventional interpretation. It finds that volatility is the determining factor. With volatility below a threshold, an inflow of foreign capital promotes growth. But during periods of volatile growth, the effect is opposite.
In a recent survey, Kose et al (2006) find little robust evidence for long-run growth benefits from global capital inflows. Prasad et al (2006) go a step further. They argue that developing countries grow faster when they rely less on foreign capital, as suggested by a positive relationship between current-account surpluses (capital outflows) and average growth (Figure 1).
International finance International trade
volatility, capital flows, uncertainty
On the tradeoff between growth and stability: The role of financial markets
Alexander Popov, Frank Smets 03 November 2011
Well-developed financial systems play a crucial role in stimulating growth but are associated with more frequent financial shocks and higher macroeconomic risk, as the financial crisis of 2007–09 reminded us. This column argues that the goal of financial regulation must be to reduce systemic risk without eliminating the financial sector’s contribution to long-term economic growth.
In the two decades leading to the Great Recession, academics had mostly converged on Schumpeter’s view that well-developed financial systems play a crucial role in stimulating economic growth. A host of academic papers had concluded that deeper domestic financial markets improve economic efficiency, lead to a better allocation of productive capital, and increase long-term economic growth (see Levine 2005 for a recent review).
growth, volatility, Finance, macroprudential regulation
The risk in carry trades
Lukas Menkhoff, Lucio Sarno, Maik Schmeling, Andreas Schrimpf 23 March 2011
The carry trade – borrowing in currencies with low interest rates and investing in currencies with high interest rates – has been a surprising hit for decades. This column provides empirical evidence suggesting that the mysteriously high returns this generates can actually be explained as compensation for the volatility risk undertaken.
The “carry trade” is the most popular trading strategy in currency markets. Traders borrow in currencies with low interest rates (negative forward premium) and invest in currencies with high interest rates (positive forward premium), profiting from the margin. Yet according to the uncovered interest parity this strategy should not work. If investors are both rational and risk-neutral, then exchange-rate changes will eliminate any gain arising from the differential in interest rates across countries.
Exchange rates International finance
exchange rates, carry trade, volatility, speculation
Does openness increase volatility? Not if countries are sufficiently diversified
Mona Haddad, Jamus Lim, Christian Saborowski 21 March 2010
Does openness increase volatility? This column argues that it doesn’t when countries are sufficiently diversified. These results amount to a powerful argument in favour of export differentiation policies as a means of deriving larger benefits from trade openness and shielding against global shocks.
The epicentre of the global economic crisis was the financial markets of the industrialised world, yet developing countries have felt the tremors. Many, including those without close financial ties to the developed world, were driven into recession as global demand plummeted and the largest drop in global trade volumes since the Second World War ensued. Naturally, open economies heavily reliant on export revenues were among those hardest hit by the crisis.
Development International trade
volatility, diversification, openness
The oil price and the macroeconomy: What’s going on?
Olivier Blanchard, Marianna Riggi 07 December 2009
In the 1970s, large increases in the price of oil were associated with sharp decreases in output and large increases in inflation. In the 2000s, even larger increases in the price of oil were associated with much milder movements. This column attributes the difference in the US to more flexible labour markets and more credible monetary policy during the Great Moderation.
Whereas in the 1970s large increases in the price of oil were associated with sharp decreases in output and large increases in inflation, in the 2000s, and at least until the end of 2007, even larger increases in the price of oil were associated with much milder movements in output and inflation. What has happened to the oil-macroeconomy relationship?
Energy Macroeconomic policy
oil shocks, volatility, expectations
Democracy, diversification, and growth reversals
David Cuberes, Michal Jerzmanowski 15 August 2009
What explains developing countries’ greater economic volatility? This column documents the relationship between democracy and growth reversals. It argues that greater democracy, not higher income, is responsible for dampening economic volatility. Greater democratisation and economic diversification would reduce both dramatic declines and growth accelerations.
The last twenty-five years have been a period of remarkable stability among developed economies. This stability, termed by some “The Great Moderation”, has been particularly noteworthy in its contrast with the instability experienced by developing economies. Poor countries suffer not only from persistently low incomes but also from large doses of economic volatility. Even the current economic crisis – which originated in financial markets of developed countries and affected their economies very severely – is causing equal if not greater damage in developing countries.
democracy, growth, volatility, diversification
Financial factors and the current account: Is volatility a concern?
Rebecca Hellerstein, Cédric Tille 21 August 2008
Financial globalisation has made current account balances more sensitive to volatile variables like asset prices and interest rates. This column says that greater current account volatility may be good news if it comes in the form of countercyclical risk sharing.
The surge in financial globalisation constitutes one of the major developments in the world economy since the mid-1990s, with Lane and Milesi-Ferretti (2007) documenting a large rise in most countries’ holdings of external assets and liabilities.
volatility, financial globalisation, Current account balance
Can we predict exchange rates? Economic evidence against the random walk model
Pasquale Della Corte, Lucio Sarno, Ilias Tsiakas 18 January 2008
The forward premium, the difference between the forward exchange rate and the spot exchange rate, contains economically valuable information about the future of exchange rates. Here is the evidence that it can help predict short-run rates and that investors who ignore it and use random walk models may be leaving money on the table.
Exchange rates are important to innumerable economic activities. Tourists care about the value of their home currency abroad. Investors care about the effect of exchange rate fluctuations on their international portfolios. Central banks care about the value of their international reserves and open positions in foreign currency as well as about the impact of exchange rate fluctuations on their inflation objectives. Governments care about the prices of exports and imports and the domestic currency value of debt payments.
exchange rates, volatility, random walk, predictions, forward premium
International Financial Stability
Roger W. Ferguson. Jr., Philipp Hartmann, Fabio Panetta, Richard Portes,
The ninth CEPR/ICMB Geneva Report on the World Economy examines the main threats to international financial stability, focusing on the implications of the major changes that have occurred in the global financial system in the past two decades.
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, subprime crisis
, financial stability
, hedge funds
Regulating the international financial system: towards a more balanced, market-based model
Richard Portes 15 November 2007
The global financial system shows signs of stress – turmoil, not a systemic financial crisis. Risk is being repriced and the unwinding will take some time. Now is the time to think carefully about longer-term reforms needed to improve the stability of the international financial system.
The global financial system shows signs of stress, but why should policy-makers care?
global imbalances, subprime crisis, financial stability, carry trade, hedge funds, volatility, large complex financial institutions, tail risk, ratings, strutured finance, buy and hold, originate to distribute