Capital Inflows Problem in Selected Asian Economies in the 1990s Revisited: The Role of Monetary Sterilization*

This paper develops a simple model to examine the reasons behind the capital inflow surges into selected Asian economies in the 1990s prior to the financial crisis of 1997–98. The analytical model shows that persistent uncovered interest differentials and consequent capital inflows may be a result of complete monetary sterilization, perfect capital mobility, sluggish response of interest rates to domestic monetary disequilibrium, or some combination of all three. Using the model as an organizing framework, the paper undertakes a series of related simple empirical tests of the dynamic links between international capital flows, the extent to which they are sterilized and uncovered interest rate differentials in the five crisis‐hit economies (Indonesia, Korea, Malaysia, the Philippines and Thailand) over the period 1990:1–1997:5.     

Capital controls and covered interest parity in the EU: Evidence from a panel-data unit root test

Capital Controls and Covered Interest Parity in the EU: Evidence from a Panel-Data Unit Root Test. - This paper examines whether the abolition of the remaining capital controls in the EU during 1990 has facilitated the achievement of onshore covered interest parity with respect to Germany. We test for unit roots in covered interest differentials. However, we employ the new methodology of pooling our data and performing a unit root test based on a panel data set. Our results suggest that the period characterized by the absence of capital controls has not facilitated the achievement of covered interest parity. Indeed, evidence in favour of covered interest parity is strongest for the period preceding 1990.     

Credibility of European economic convergence

Credibility of European Economic Convergence. — The authors analyze economic convergence and its relation to European real interest rate differentials using a clustering method on seven macroeconomic key variables for 1979–1995. The results indicate that monetary convergence has progressed considerably but that there is hardly any real convergence in the EU. They also perform pooled nominal and real interest rate regressions with the individual cluster indicators as explanatory variables. The authors find significant positive effects of external (current account) and internal (unemployment ratios, government finance) imbalances on real interest rates. They also group countries according to economic reputation and find that real indicators remain significant for the high-reputation countries.     

Accounting for the stock of human capital: Selected evidence and potential implications

Accounting for the Stock of Human Capital: Selected Evidence and Potential Implications. — Given the observed distribution of output and labor across countries, most capital flows should be from rich to poor countries. As is shown for a limited sample of countries, accounting for differences in the stock of human capital substantially reduces the implicit cross-country rate of return differentials. Additionally, accounting for human capital externalities based on independent empirical evidence, turns around the predicted rate of return differentials in favor of rich countries. Hence, the world economy may converge to a rather unequal distribution of incomes as long as human capital accumulation is neglected as the key variable limiting economic development.     

Risk Related Non Linearities in Exchange Rates: Evidence from a Panel of Central and Eastern European Countries

This paper investigates the recent evolution of five Eastern European exchange rates. Our aim is twofold: to provide an up-to-date view of the predictability and main relations of spot rates with economic fundamentals and to derive some considerations about exchange rate regimes, capital flows, and risk appetite. We propose a non-linear specification where the non-linearity refers to the effect of the interest rate differential. The paper supports the view that given the relevance of capital flows and their sensitivity to risk adjusted yield differentials, the choice of exchange rate regime should be a matter of careful strategy.     

The Impact of the US Interest Rate Hike on Emerging Market Economies and the Belt and Road Initiative

Since the end of 2015, the US Federal Reserve has raised its benchmark interest rate nine times. This has led to capital outflows and asset depreciation in many emerging market economies. The present paper examines the factors that determine the financial volatility of emerging markets in the face of external shocks. By calculating the capital flows of 30 emerging markets from 1990 to 2018 and conducting panel regression, this paper finds that countries with good infrastructure facilities, a sound banking system and high economic growth have significantly lower cross‐border financial risks. An implication from the empirical analysis is that emerging countries would benefit greatly by actively taking part in the Belt and Road Initiative. The framework of the Belt and Road Initiative allows emerging countries better access to China's massive consumer market to promote trade and long‐term growth. Their quality of infrastructure can be improved through cooperation with China in infrastructure investment. They can also jointly establish a cooperative financial framework to enhance regional financial stability. These strategies will reduce systematic financial risks and counteract the negative impacts of US interest rate hikes.     

Horizontal and vertical intra-industry trade between Eastern Europe and the European union

Horizontal and Vertical Intra-Industry Trade Between Eastern Europe and the European Union. — The share of intra-industry trade (IIT) in total trade between central and east European nations and the EU is broken down into various components. Vertical IIT is found to account for 80 to 90 percent of total IIT. Controlling for country-specific effects, it is positively associated with product differentiation, labor intensity of production, economies of scale, and foreign direct investment (FDI). Horizontal IIT is also positively correlated with FDI and product differentiation; however, a significant negative relationship is found for scale and labor intensity.     

FINANCIAL AND MONETARY AUTONOMY AND INTERDEPENDENCE BETWEEN SOUTH AFRICA AND THE OTHER SACU COUNTRIES

The paper uses cointegration and error correction modelling techniques together with tests of weak exogeneity, and monthly interest rates for the period 1990 to 2005, to examine the degree of financial and monetary autonomy and interdependence between South Africa and the other Southern African Customs, Union (SACU) countries. The results reveal a high level of dependence of the other SACU countries' financial systems on South Africa's financial system, which suggests that a monetary unification with a single central bank (South African Reserve Bank) and monetary policy for the union is feasible.     

The role of comparative advantage in trade within industries: A panel data approach for the European Union

The Role of Comparative Advantage in Trade within Industries: A Panel Data Approach for the European Union. — A large share of EU member states trade is intra-industry trade (IIT) in the period 1985-1996; in particular, IIT is based on products differentiated in quality (vertical IIT). Moreover, exports from southern countries are located mainly at the lower end of the price-quality spectrum, whereas those countries with higher per capita incomes are located at the higher end. According to the vertical IIT models, we hypothesize that commercial specialization of members states over the quality spectrum within industries is explained by differences in technological, physical and human capital. The results show that comparative advantage is an important driver of the pattern of European trade within industries.     

Capital controls and international trade finance in a dual exchange rate regime: The Belgian experience post-mortem

Capital Controls and International Trade Finance in a Dual Exchange Rate Regime: The Belgian Experience Post-Mortem. — The purpose of the paper is to model “leads and lags” capital flows on the official segment of a dual exchange market and to examine the effects of various types of capital controls imposed by authorities on the official spot and forward exchange markets. The focus of the analysis is the degree of insulation provided by a “dual exchange market cum capital controls” in face of a speculative crisis. The crucial variables in this respect are the deviation from covered interest parity and the forward risk premium. Results of the theoretical model are confronted with empirical evidence over the 1975–85 period.     

A cointegration approach to capital mobility: Evidence for Belgium

This paper provides a method for measuring capital mobility through the analysis of causality direction between the exchange rate and the interest rate. Empirical evidence is provided for Belgium. Cointegration and Granger causality tests show that the direction of causality between both variables reverses in 1979 when an increase in the degree of European financial integration took place.     

Exchange rates and European countries’ export prices: An empirical test for asymmetries in pricing to market behavior

Exchange Rates and European Countries’ Export Prices: An Empirical Test for Asymmetries in Pricing to Market Behavior. — This paper uses forward instead of spot exchange rates to test for the presence of asymmetries in the response of export prices to exchange rate movements on a wide sample of European Union exporter countries and highly disaggregated product categories. In most cases, the data give support to the hypothesis of a symmetric pricing to market behavior during periods of depreciation and appreciation of the exporter’s currency.     

International Monetary and Financial Arrangements: Present and Future

The paper deals with a broad range of topics under the rubric of the international monetary system: exchange rate agreements, International Monetary Fund structure, history and functioning of the European Monetary Union, monetary and fiscal policies adopted in recent years by different countries, with a special emphasis on central bank independence and inflation control, capital flows and cross-border assets growth and their influence on financial stability, and policy proposals to enhance financial stability. With more than four-fifths of world trade conducted under managed or full flexibility the present system can be regarded more as a flexible than a fixed exchange rate regime. EMU is a major institutional innovation; while its economic benefits have been amply discussed and perhaps exaggerated, the economic costs seem to have been underestimated. Financial liberalization has resulted in huge benefits to savers and borrowers as capital has tended to flow to its most productive uses around the world, but it has also led to fears that this has sharply reduced the effectiveness of monetary policy. This liberalization imposes a constraint on monetary policy in the sense that it forces a much higher degree of economic convergence than was true before.     

Dual-track interest rates and capital misallocation

The control-track interest rate and the market-track interest rate constitute China's dual-track interest rates. A theoretical model of dual-track interest rates and financial frictions is studied. In the model, bank loans are provided to state-owned enterprises with the control-track interest rate, private enterprises resort to shadow banking with the market-track interest rate. The interest rate wedge between these two interest rates distorts capital allocation, even driving a sector out of production. Full interest rate liberalization which eliminates the interest rate wedge alleviates cross-sector capital misallocation. However, the net effect on aggregate TFP is ambiguous due to the within-sector effect. Under calibrated parameters, full interest rate liberalization improves aggregate TFP moderately, unless the financial reform aimed to have SOEs and POEs face the same degree of financial frictions is also implemented.     

Nonlinear Capital Flow Tax: Capital Flow Management and Financial Crisis Prevention in China

How to promote capital account liberalization while preventing financial crises is a challenging task for policymakers. This study proposes a nonlinear (progressive) capital flow tax as a solution. We first demonstrate that the collateral requirement of international borrowing can give rise to multiple equilibria and self‐fulfilling financial crises. We then show that the crisis equilibrium characterized by large exchange rate depreciation, capital flight and welfare loss can be eliminated by imposing a nonlinear (progressive) tax scheme on capital outflows with the marginal tax rate increasing with the size of individual capital outflows. The implementation of such a tax scheme in China is also discussed.     

Bubble into reallocation: How bubbles improve capital allocation in China

This paper develops a theoretical framework to shed lights on the relations between the segmented financial market and the housing bubble in China. In our framework, capital misallocation across firms plays a central role. The segmented financial market causes discrimination against private enterprises and favoritism to state-owned firms. This biased financial system not only gives rise to capital misallocation across firms but also significantly pushes down the equilibrium interest rate in the formal financial market. The overly low interest rate in the formal financial market causes a rational bubble in a dynamically efficient economy. More importantly, the bubble improves capital allocation across firms by crowding out inefficient investment in the state-owned sector. Despite the role of improving capital allocation, bubbles may still reduce welfare by crowding out aggregate capital.     

Default premia on European government debt

Default Premia on European Government Debt. — This paper addresses the question of the existence and size of a risk premium in the Eurobond market. We measure the yield difference between German government bonds and bonds issued in Deutsche Mark by several European countries. The results are regressed against macroeconomic variables supposed to be determinants of the risk of default on government debt. Our yield differences are smaller than those found between US states. However, some of our macroeconomic variables seem to be good predictors of yield differentials. A conclusion is that yield differentials partially are related to risks perceived by market participants.     

Testing for the uncovered interest parity condition in a small open economy: A state space modelling approach

Do interest rate differentials smoothly mirror the changes in the exchange rate between a small open economy and a large emerging market economy? The literature provides conflicting views on the validity of the uncovered interest parity condition (UIP), including its size and factors influencing the risk premium. We examine the validity of the UIP condition between Nepal and India using time-series data covering the period 1989 – 2019. A state space modelling approach based on the Kalman filter analysis is applied to simulate the risk premium. We find that the UIP condition does not hold for the Nepalese Rupee. A time-varying persistent negative risk premium that dominantly explains interest rate differentials is, instead, found. These findings imply that Nepalese residents prefer to hold foreign assets and continually expect future devaluations of the domestic currency. These present obstacles to developing domestic financial markets and the implementation of a market oriented monetary policy.     

Accounting for Skill Premium Patterns: Evidence from the EU Accession

In this article, we decompose the joint and individual contributions of tariff reductions, productivity changes and capital deepening to account for the skill premium patterns of the transition economies that joined the European Union (EU) in 2004. To conduct our accounting analysis, we construct an applied general equilibrium model with skilled and unskilled labor, and combining Social Accounting Matrices, Household Budget Surveys and the EU KLEMS Growth and Productivity Accounts database, we calibrate it to match Hungarian data, a transition economy where the skill premium consistently increased between 1995 and 2005. We find that capital deepening coupled with capital‐skill complementarity is the main force behind the rise in the skill premium.     

Real interest parity: A note on Asian countries using panel stationarity tests

Existing panel data studies of real interest parity are either unable to identify which panel members are characterised by stationary real interest differentials, or are subject to size distortion resulting from the presence of structural breaks and cross-sectional dependencies. Using a panel stationarity testing procedure recently advocated by Hadri and Rao (2008) that allows for structural breaks and cross-sectional dependency, we are unable to reject the stationarity of Asian real interest rate differentials.