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MACROECONOMIC VULNERABILITY MANAGING PRO-CYCLICAL CAPITAL FLOWS

VIEWS: 7 PAGES: 26

									MACROECONOMIC VULNERABILITY:
   MANAGING PRO-CYCLICAL
       CAPITAL FLOWS




     JOSÉ ANTONIO OCAMPO
      COLUMBIA UNIVERSITY

                               1
         BASIC ISSUES (1)

Broad view of macroeconomic stability: not only
inflation and fiscal balance, but also:
  Economic activity and employment
  External sector balance
  Balance sheets of financial and non-financial
  agents
Developing countries are subject to strong
cyclical shocks.
Basic lesson from the past: following incentives
generated by positive terms of trade and capital
account shocks leads to crises.
                                                   2
           BASIC ISSUES (2)
So, need to develop counter-cyclical
macroeconomic policies …
… but limited “policy space” for them.
This issue is generally ignored by in traditional policy
debates:
  The “trilemma” and polar exchange rate regimes.
  Inflation targeting cum flexible exchange rates and
  open capital accounts.
On the contrary, some “revealed preferences” of
authorities make sense, particularly “self-insurance”
through foreign exchange reserve accumulation and
heavy interventions in foreign exchange markets.
                                                           3
            THE TRADITIONAL VIEW:
            THE IMPOSSIBLE TRINITY

                     Capital mobility




                 A                      B


  Autonomy                                    Autonomy
  to manage               C                   to manage
interest rates                              exchange rates

                                                             4
MACROECONOMIC (IN)STABILITY

Markets are inherently cyclical
This is true of commodity markets …
…but particularly of financial markets:
  Alternation of high “risk appetite” and “flight to
  quality”
  Rationing of credit, particularly during downturns
  Contagion
Features of financial cycles:
  Variations in availability, price and maturities
  Short-term but, particularly, medium-term
  fluctuations
                                                       5
                             UNSTABLE ACCESS TO
                            EXTERNAL FINANCING…


                        Private capital flows to developing countries
700

600

500

400                                                                                                                           Private debt
                                                                                                                              Portfolio equity
300                                                                                                                           FDI

200

100

  0
       1990
              1991

                     1992

                            1993

                                   1994

                                          1995
                                                 1996

                                                        1997

                                                               1998
                                                                      1999

                                                                             2000

                                                                                    2001
                                                                                           2002

                                                                                                  2003
                                                                                                         2004

                                                                                                                2005

                                                                                                                       2006
-100


                                                                                                                                                 6
                        … AND VOLATILE SPREADS …
                      EMBI Global and US High-Yield Bonds, October 1994 to 2008 YTD

               1800   Mexican
                      Crisis
               1600
                                  Asian
                                  Crisis            EMBI/EMBI
               1400
                                                    Global
               1200
Basis Points




               1000


               800                                                                                     US High-Yield Bonds

               600


               400
                                                         Pre-Asian Crisis EM Spreads
               200


                  0

                   94 95 95 96 96 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08
                ct- pr - ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr-
               O A O A O A O A O A O A O A O A O A O A O A O A O A O A
                                                                                                                                   7
                                                      10.0



                                                                           11.0



                                                                                  12.0
                5.0



                      6.0



                                    7.0



                                          8.0



                                                9.0
    1-Jan-04

    1-Mar-04

    1-May-04

     1-Jul-04

    1-Sep-04




                                                                                                           … WITH SHORTER-TERM
                                                                                                           … WITH SHORTER-TERM
    1-Nov-04
                            EM




    1-Jan-05




                                                          July 04-Feb 06
    1-Mar-05




                                                                                                              FLUCTUATIONS
                                                                                                              FLUCTUATIONS
    1-May-05
                            Latin




     1-Jul-05

    1-Sep-05




                                                                                    Yields: EM and Latin
    1-Nov-05

    1-Jan-06
    1-Mar-06

    1-May-06
                                                         July 06-Apr 07




     1-Jul-06

    1-Sep-06

    1-Nov-06

    1-Jan-07
    1-Mar-07

    1-May-07
                                                           Sep 07-May 08




     1-Jul-07

    1-Sep-07

    1-Nov-07

    1-Jan-08
    1-Mar-08

    1-May-08

     1-Jul-08

    1-Sep-08
8
COUNTER-CYCLICAL POLICIES

Counter-cyclical fiscal policies
Counter-cyclical monetary policies
Foreign exchange reserve accumulation
Development of domestic bond markets
Capital account regulations
Counter-cyclical prudential regulation.

                                          9
           FISCAL POLICY
Fiscal policy can always play a counter-cyclical
role.
But markets push it in a different direction, as
taxes and financing are pro-cyclical
And there are political-economy pressures that
push in the same direction:
  If there was austerity during the preceding crisis,
  it is also difficult to justify it during booms
  Compensating pro-cyclical booms of private
  spending is politically difficult
Procyclical fiscal policy has adverse effects on
the efficiency of public sector spending and on
growth.
                                                        10
FISCAL POLICIES IN THE DEVELOPING
 WORLD TEND TO BE PRO-CYCLICAL

                              CYCLICALITY OF
           REGION          FISCAL POLICY (INDEX)
OECD                    - 0.11      (countercyclical)
High-to-Middle Income   0.28      (highly procyclical)
Developing Countries

Middle-to-Low Income    0.17 (moderately procyclical)
Developing Countries

Low-Income Countries    0.28      (highly procyclical)
Africa                  0.30     (highly procyclical)
Latin America           0.25     (highly procyclical)
Asia                    0.16 (moderately procyclical)


                                                         11
  FISCAL POLICY OPTIONS

Actively use stabilization funds
Define a structural stance of the public
sector.
Automatic stabilizers (spending or
taxes) may be preferable to discrete
decisions.



                                           12
i = i * + ρ + eE
              ˆ



                         COUNTER-CYCLICAL
                        MONETARY POLICIES (1)
                    A counter-cyclical rule is implicit in the inflation
                   targeting paradigm …
                    … but pro-cyclical capital flows generate swings
                   in parity interest rates (i=i*+θ+ê) that have pro-
                   cyclical effects…
                   … as well as supply shocks that run counter to
                   expectations of the dominant paradigm.
                    In sum, a succession of boom-cum price
                   stability (“boombility”) and stagflation pressures.

                                                                           13
    COUNTER-CYCLICAL
   MONETARY POLICIES (2)
 So, authorities may have limited room to
counter the pro-cyclical swings of markets.
The attempt to do with through flexible
exchange rates simply shifts the problem to the
exchange rate …
 … generating risks of balance of payments
crises …
 … and unstable incentives for international
specialization.
                                                  14
        FOREIGN EXCHANGE
         ACCUMULATION (1)

If adequately sterilized, it is possible to target
both the exchange and the interest rate.
This resolves also the conflicting demands on
the exchange rate regime:
   Demand for stability (price stability, stable trade
   incentives, avoiding pro-cyclical wealth effects)
   Demand for flexibility (room of maneuver to
   manage shocks)
Some form of “exchange rate targeting” is the
normal policy option: the “revealed preference”
of the authorities has been to be inside the
triangle of the “impossible trinity”.
                                                         15
THREE THEORIES OF RESERVE
      ACCUMULATION

Mercantilist: “Second Bretton Woods” literature.
“Self-insurance”: protection against capital
outflows. To the extent that medium-term
cycles are important, reserves should be
proportional to total external liabilities.
“Financial stability” (Obstfeld, Shambaugh and
Taylor): protection against capital flight.
Magnitude and timing of reserve accumulation
may be read as implying that “self-insurance” is
the dominant motive.

                                                   16
     DEVELOPING COUNTRIES HAVE
ACCUMULATED PART OF EXPORT REVENUES
      AND ALL CAPITAL INFLOWS
                      Reserve accumulation by developing countries
                              (% of GDP at market prices)
10.0%



8.0%



6.0%



4.0%
                                                                                                     Capital flow s
                                                                                                     Current account
2.0%



0.0%
        1995   1996     1997   1998   1999   2000   2001   2002   2003   2004   2005   2006   2007


-2.0%



-4.0%
                                                                                                                      17
                 MASSIVE INTERVENTIONS IN
                FOREIGN EXCHANGE MARKETS
                          A cu m u lac ió n d e re se rv as co m o % de l P IB )              14 .3 %
1 0.0 %
                                                                        Jul0 4-Abr06
                                                                        Jul0 6-Jun07
                                                                        E n-Jun 08
 8.0 %




 6.0 %




 4.0 %




 2.0 %




 0.0 %
          A rg en tin a      Bra sil        C hile       Co lo m b ia            Mé xico   Pe rú


-2.0 %
                                                                                                        18
     PROMOTE DOMESTIC
       BOND MARKETS
Three key issues:
  Trade-off between currency and maturity
  mismatches.
  With open capital accounts, pro-cyclicality
  associated with exchange rate expectations.
  Moving from a government bond market to one
  that also includes corporate bonds.
Some policies may be useful to reduce
these problems:
  Taxation or reserve requirements on shorter
  term bonds
  Minimum stay periods for foreign holdings
  Avoiding domestic dollarized assets.          19
DOMESTIC BOND MARKETS HAVE
BOOMED SINCE THE ASIAN CRISIS
       1
   Asia
                2
   Latin America                             3,500
                  3
   Central Europe
                            4                3,000
   Other developing markets
                                             2,500

                                             2,000

                                             1,500

                                             1,000

                                             500

                                             0
 94 95 96 97 98 99 00 01 02 03 04 05 06 07

                                                     20
        CAPITAL ACCOUNT
         REGULATIONS (1)
Two objectives:
  Macro: increase space for counter-cyclical monetary
  policy
  Debt management: improve debt profiles.
Second best intervention: segment what is
already segmented.
Traditional regulations: segment according to
residents and non-residents, and existing
economic links.
For countries already integrated in to world
capital markets:
  Temporary administrative controls
  Price-based regulations (Unremunerated
  Reserve Requirements, URR).
                                                        21
THE EFFECT OF CAPITAL-ACCOUNT
         REGULATIONS
  Inflows




                                A

                                                 C


                                    B


                                               Interest rate spread
                                               (i - i* + e)
            i: Domestic real interest rate
            i*: External real interest rate
            e: Annual variation of of the real exchange rate

                                                                      22
         CAPITAL ACCOUNT
          REGULATIONS (2)
Lessons from experience:
  Both controls on outflows and inflows can work,
  but quantitative restrictions may be easy to
  administer
  Dynamic adjustment is necessary to close
  loopholes, and in any case regulations are
  “leaky”
  Traditional controls work better if the objective is
  to reduce procyclical flows.
  Quantitative controls have stronger effects, but
  price-based regulations are also effective
  Their effect may be temporary
  Capital account regulations are a complement,
  not a substitute of adequate macro policy
Despite positive lessons of the past, few
countries used them during the recent crisis.            23
        MACRO-PRUDENTIAL
          REGULATIONS
Risks that financial sector faces have a large
macroeconomic component:
  Financial markets are pro-cyclical
  Traditional regulation have a pro-cyclical bias
  Mark-to-market and other price-sensitive risk
  management is also pro-cyclical.
Essential tools:
  Forward-looking provisioning (or capital)
  Discretionary prudential provisioning, based on
  growth of credit (general, by sector, by agent)
  Regulation of maturity and, particularly, currency
  mismatches.
  Valuation of collaterals to avoid asset price
  bubbles from feeding into leverage.                  24
              CONCLUSIONS
 The essential problem of macroeconomic policy in the
mix of pro-cyclical capital flows and the limited room of
maneuver for counter-cyclical macroeconomic policies
that they generate.
 Dominant frameworks are not always useful to
analyze the dilemmas involved, as they don’t look
through the whole business cycle.
 Active counter-cyclical policies involve multiple
instruments, including active foreign exchange reserve
management, elements of exchange rate targeting,
counter-cyclical prudential regulations and, possibly,
capital account regulations.
 The support for counter-cyclical policies must be at
the center of international (IMF) cooperation.
                                                            25
MACROECONOMIC VULNERABILITY:
   MANAGING PRO-CYCLICAL
       CAPITAL FLOWS




     JOSÉ ANTONIO OCAMPO
      COLUMBIA UNIVERSITY

                               26

								
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