Managing Capital Flows

Managing Capital Flows

The Search for a Framework

ADBI series on Asian Economic Integration and Cooperation

Edited by Masahiro Kawai and Mario B. Lamberte

Managing Capital Flows provides analyses designed to help policymakers develop a framework for managing capital flows that is consistent with prudent macroeconomic and financial sector stability.

Chapter 3: Central Banks and Capital Flows

Stephen Grenville

Subjects: asian studies, asian economics, development studies, development economics, economics and finance, asian economics, development economics

Extract

Stephen Grenville 3.1 HOW HAVE INTERNATIONAL CAPITAL FLOWS CHANGED THE POLICY ENVIRONMENT? We start with the presumption that international capital flows, like international trade flows, are a Good Thing. They give the opportunity for a capital-constrained emerging country to tap into the world supply of savings, not only increasing the quantity of funds available to it, but also reducing the cost (just as globalized trade opens up opportunities to buy more cheaply). The Feldstein/Horioka (1980) paradox suggests that there is room for much more international trade in capital to allow investment to take place in those countries with high marginal productivity of capital, whether or not they are also high savers. Over time, the paradox seems to be lessening. This would lead us to expect that on average over time, international capital will flow from the mature countries to the emerging countries, and that these flows will become larger over time as the path of transmission becomes smoother, information become more available and institutional channels develop more depth. How long can these inflows be expected to persist? The simple answer is ‘as long as there is a difference in the marginal return to capital’. We can remind ourselves of how these flows affect the macro-economy. If there is an autonomous increase in inflow, this can only be absorbed in terms of real goods and services if the exchange rate appreciates and the current account moves in the direction of deficit by the same amount as the capital flow.1 This is...

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