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Liberalized Portfolio Capital Inflows in Emerging Markets: Sterilization, Expectations, and the Incompleteness of Interest Rate Convergence

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  • Frankel, Jeffrey A
  • Okongwu, Chudozie

Abstract

This paper examines interest rates in nine Latin American and East Asian countries during the period 1987-94. The goal is to discover why interest rates remained high, failing to converge to US levels, despite capital market liberalization and a resurgence of portfolio capital inflows during the second half of this sample period. Related questions are whether portfolio capital flows are strong enough to equalize expected returns between these "emerging markets" and the US, and whether there is any scope left for the authorities to sterilize inflows. The conclusion of the study is that the largest single component of the gap in interest rates is expectations of depreciation of the local currencies against the dollar. The key to the analysis is the use of survey data on exchange rate forecasts by market participants. Indicative of integrated financial markets, we also find a big effect of US interest rates on local interest rates, and a highly significant degree of capital flow offset to monetary policy. Copyright @ 1996 by John Wiley & Sons, Ltd. All rights reserved.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 1 (1996)
Issue (Month): 1 (January)
Pages: 1-23

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Handle: RePEc:ijf:ijfiec:v:1:y:1996:i:1:p:1-23

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  1. Frankel, Jeffrey A & Chinn, Menzie D, 1993. "Exchange Rate Expectations and the Risk Premium: Tests for a Cross Section of 17 Currencies," Review of International Economics, Wiley Blackwell, vol. 1(2), pages 136-44, June.
  2. Kouri, Pentti J K & Porter, Michael G, 1974. "International Capital Flows and Portfolio Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 82(3), pages 443-67, May/June.
  3. Froot, Kenneth A & Frankel, Jeffrey A, 1989. "Forward Discount Bias: Is It an Exchange Risk Premium?," The Quarterly Journal of Economics, MIT Press, vol. 104(1), pages 139-61, February.
  4. Kamas, Linda, 1985. "External disturbances and the independence of monetary policy under the crawling peg in Colombia," Journal of International Economics, Elsevier, vol. 19(3-4), pages 313-327, November.
  5. Leonardo Leiderman & Carmen Reinhart & Guillermo Calvo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Working Papers 92/62, International Monetary Fund.
  6. Menzie Chinn and Jeffrey Frankel., 1993. "Patterns in Exchange Rate Forecasts for 25 Currencies," Center for International and Development Economics Research (CIDER) Working Papers C93-009, University of California at Berkeley.
  7. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1996. "Inflows of capital to developing countries in the 1990s," MPRA Paper 13707, University Library of Munich, Germany.
  8. Guillermo A. Calvo, 1991. "The Perils of Sterilization," IMF Staff Papers, Palgrave Macmillan, vol. 38(4), pages 921-926, December.
  9. Vittorio Grilli & Gian Maria Milesi-Ferretti, 1995. "Economic Effects and Structural Determinants of Capital Controls," IMF Staff Papers, Palgrave Macmillan, vol. 42(3), pages 517-551, September.
  10. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1994. "The capital inflows problem: Concepts and issues," MPRA Paper 13902, University Library of Munich, Germany.
  11. Calvo, Sara & Reinhart, Carmen, 1996. "Capital flows to Latin America : Is there evidence of contagion effects?," Policy Research Working Paper Series 1619, The World Bank.
  12. Kamas, Linda, 1986. "The Balance of Payments Offset to Monetary Policy: Monetarist, Portfolio Balance, and Keynesian Estimates for Mexico and Venezuela," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(4), pages 467-81, November.
  13. Michael P. Dooley & Eduardo Fernandez-Arias & Kenneth M. Kletzer, 1994. "Recent Private Capital Inflows to Developing Countries: Is the Debt Crisis History?," NBER Working Papers 4792, National Bureau of Economic Research, Inc.
  14. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1994. "Capital Inflows to Latin America: The 1970s and 1990s," MPRA Paper 8196, University Library of Munich, Germany.
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