Capital Flows and Leverage

This article surveys the literature on capital flows and leverage. We summarize results from the existing papers and document new facts. The empirical literature takes both a macro and a micro approach. The macro approach focuses on aggregate data both over time and in the cross-section of countries, and it documents a positive correlation between total capital flows, build-ups in terms of external and domestic debt to GDP ratio, and financial crises. The micro approach uses granular data and focuses on leverage at the firm and bank level and associates this leverage with country-level capital flows and related exchange rate movements. We document new facts from a hybrid approach that focuses on the relationship between sector-level capital flows and sectoral leverage. We highlight the interconnections between different approaches and argue that harmonization of the macro and micro approaches can yield a more complete understanding of the effect of capital flows on country-, sector-, and firm- and bank-level leverage associated with credit booms and busts.