The Multilateral Aspects of Policies Affecting Capital Flows

Karl Habermeier, Assistant DirectorMark Stone, Deputy Division Chief

Monetary and Capital Markets Department 

December 20, 2011 

Context Fund is undertaking considerable work on

policies affecting capital flows Motivated by:

Greater cross-border interconnectedness Experience of the crisis G-20 and IMFC have called for a

“comprehensive, balanced and flexible approach for managing capital flows”

The current work-stream follows on the view developed at the Fund 10 years ago

Fund capital flow work-stream

The Fund’s role regarding flows (December 2010)

Experiences in managing capital inflows (March 2011)—framework for capital flow management measures (CFMs)

Multilateral aspects (today) Focus on source countries Focus on broad array of policies

Capital outflows and capital acc. liberalization—March 2012

Chapeau paper—mid-2012

Organization of presentation Reconsidering the stylized facts of capital flows

Advanced economy regulation and supervision and global reforms

The impact of advanced economy monetary policy on capital flows

Capital flow management measures

Conclusions and extension of the proposed framework

Organization of presentation Reconsidering the stylized facts of

capital flows Advanced economy regulation and

supervision and global reforms The impact of advanced economy

monetary policy on capital flows Capital flow management measures Conclusions and extension of the

proposed framework

Stylized fact 1: intra-AE gross flows embed potential systemic risks

Previous focus on net flows to EMEs, and on the composition of flows

The recent crisis showed that gross flows between AEs can be destabilizing

Flows to EMEs originate from the same small group of AEs that dominate inter-AE flows

Implication: strong transmission of AE policies

Figure 1. Global Capital Flows1980-2010

Source: World Economic Outlook

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1980 1984 1988 1992 1996 2000 2004 2008

Advanced economiesIn percent of global GDP

Inflows (liabilities, left)

Outflows (assets, left)

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1980 1984 1988 1992 1996 2000 2004 2008

Emerging marketsIn percent of global GDP

Net (right)

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1980 1984 1988 1992 1996 2000 2004 2008

Advanced economiesIn percent of own GDP

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1980 1984 1988 1992 1996 2000 2004 2008

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Stylized fact 2: Global SIFIs bear directly on the riskiness of capital

flows Volatile bank flows suggests banks did not

internalize the associated risks

Expansion in portfolio flows means a larger share of capital flows outside of regulation

Business model of many G-SIFIs model helped drive an increase in shadow banking and global liquidity

Implication: G-SIFI regulation is important

Stylized fact 3: The volume and volatility of EME capital flows are on

upward trends

Gross EME inflows more volatile

Net EME capital flows remain large

Capital inflows have been trending upwards in EMEs Declines in home bias in AEs Widening growth differentials Financial market development

Implication: transmission of AE policies may get stronger

Figure 2. Volatility in Capital Flows(Coefficient of variation

in percent)

Figure 3. Trends in Gross and Net Flows

(Hodrick-Prescott filtered series, billions of U.S. dollars)

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1995 1997 1999 2001 2003 2005 2007

Emerging markets

Advanced economies

Coefficient of variation in percent

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1980 1985 1990 1995 2000 2005 2010

Gross inflows

Gross outflows

Sources: World Economic Outlook and staff calculations.

Sources: World Economic Outlook and staff calculations.

Organization of presentation Reconsidering the stylized facts of

capital flows Advanced economy regulation and

supervision and global reforms The impact of advanced economy

monetary policy on capital flows Capital flow management measures Conclusions and extension of the

proposed framework

AE regulation and supervision: motivation

Traditional focus: national microprudential

Limited attention paid to cross-border issues

Crisis showed shortcomings in R&S that transmitted across borders

Paper looks at the recent past, present and future of AE regulation and supervision

AE regulation and supervision: the recent past Five specific cross-border risks not adequately

appreciated by supervisors

1. Foreign exchange liquidity risk—e.g. large European banks, AE banks in Europe EMEs, AIG

2. Counterparty risk—exposure to AIGFP, US MMMFs

AE regulation and supervision: the recent past

3.Indirect exchange rate risk—Fund in FX and lend in FX to borrowers who earn in LC

4.Mortgage market risk—National mortgage market risks transmitted globally

5. Credit concentration risk—Foreign affiliates concentrated in regions

AE regulation and supervision: summary of the

recent past These risks contributed to cross-country

stress and undermined confidence in the global system

Regulatory perimeter is key policy implication

Macroprudential perspective needed

Problem of lack of feedback to large countries undermining their incentives

Box 2 has specific policy recommendations

AE regulation and supervision: the present

Discussion in the paper already a little dated!

Systemic financial stress is on the rise

Low interest rates having subtle effect

Flows are already becoming more unstable

R&S reform urgently needed to mitigate these risks

AE regulation and supervision: the future

Enormous agenda now underway But progress has been mixed This means regulatory arbitrage

opportunities Capital and liquidity requirements Carving out of risky activities Financial markets Supervisory perimeter

Downside reform dynamic must be avoided

AE regulation and supervision: policy

messages Crisis taught us that national R&S

has important multilateral effects Completing national R&S reform is

win-win Complete and implement national

macroprudential frameworks Complete and implement

international architecture reforms Cross-border coordination

Organization of presentation Reconsidering the stylized facts of

capital flows Advanced economy regulation and

supervision and global reforms The impact of advanced economy

monetary policy on capital flows Capital flow management measures Conclusions and extension of the

proposed framework

AE monetary policy: overview

Big issue is whether expansionary US MP increased flows to EMEs after crisis

Channels Interest rate differentials Growth differentials

Literature review: powerful effect Based on pre-crisis Overall effect Differences across investors and types of flows

AE monetary policy: QE impact on long-term interest rates

ZLB prompted Fed and BoE shift to QE to lower long-term yields

QE—Bond purchases for macro purposes

Most empirical analysis based on event studies—QE1 reduced yields by 50 basis points, QE2 smaller

The interest rate effect likely increased capital flows to EMEs

AE monetary policy: other QE channels

QE can narrow growth differentials and thus reduce flows to EMEs

Some model-based evidence of domestic growth effect

Counterfactual of no QE could have led to much sharper world recession

AE monetary policy: conclusion

Weak case for active consideration by central banks of multilateral effects

Clear-cut case when domestic and multilateral objectives coincide

But usually very difficult to assess Issue of mandate of large AE central

banks Fully effective R&S of AEs would help

Organization of presentation Reconsidering the stylized facts of

capital flows Advanced economy regulation and

supervision and global reforms The impact of advanced economy

monetary policy on capital flows Capital flow management measures Conclusions and extension of the

proposed framework

Capital flow management measures: background

CFMs are administrative, tax, and prudential measures designed to influence capital flows

Two flavors: “Capital controls”—discriminate on the basis of residency “Other measures”—do not discriminate on the basis of

residency e.g. some macroprudential measures

Renewed popularity has led to new cycle of work CFMs can effectively manage inflows in a policy package Can have adverse effects domestically Unilateral impact seems to be limited

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1/ The table includes CFMs and related measures used by a sample of countries to cope with capital inflows since 2009Q4 based on an updated version of Table 4 of SM/11/30. A measure or set of measures taken by a country in a particular month is counted as one event.

Figure 4. Capital Flows Management Measures and Related Measures

Source: IMF Country Desks

Capital flow management measures: multilateral aspects

Focus here on CFMs aimed to address inflows

CFM can be expected to reduce asset prices and inflows in the home country

CFMs could transmit multilaterally via capital flows to likewise countries with similar characteristics: Divert flows and increase asset prices and inflows in likewise Reduce flows and decrease asset prices and inflows in likewise

Event studies suggested CFMs can increase or decrease flows to likewise countries

Capital flow management measures: implications

As of today, CFMs seem to have limited implications for the riskiness of flows Modest unilateral effectiveness Inconclusive multilateral transmission Market participants view them as ineffective

Downside risk of CFM proliferation Adverse dynamic (trade wars) Closure of capital accounts limits benefits of

capital flows

Organization of presentation Reconsidering the stylized facts of

capital flows Advanced economy regulation and

supervision and global reforms The impact of advanced economy

monetary policy on capital flows Capital flow management measures Conclusions and extension of the

proposed framework

Extension of policy framework

Bottom line: national authorities should pay more attention to policy transmission, especially prudential

Fund previously proposed framework to address domestic aspects of CFMs for recipient countries

This paper proposed extending framework to help: policymakers understand how risks transmit across

borders promote policy coordination

Extension of policy framework

National supervisors should understand risk cross-border transmission and be prepared to take countervailing measures

National supervisors should have the appropriate capacity and perimeter

Macroprudential policy should account for capital flows, and coordinate across countries

Complete and fully implement the ongoing international architecture reforms

Reaction to paper Broad agreement by Directors on the conclusions

of the paper Discussion of AE monetary policy Discussion of applicability of extension of the framework

Extensive press coverage

Next steps Paper on capital account liberalization Chapeau paper

Questions