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Capital Inflows, Inflation and Exchange Rate Volatility : An Investigation for Linear and Nonlinear Causal Linkages

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  • Abdul Rashid

    (Pakistan Institute of Development Economics)

  • Fazal Husain

Abstract

Since the early 1990s, there is an upsurge in foreign capital flows to developing economies, particularly into emerging markets. One view argues that capital inflows do help to increase efficiency, a better allocation of capital and to fill up the investment-saving gap. Adherents to that view advise countries to launch capital account liberalisation. In this study, we investigate the effects of capital inflows on domestic price level, monetary expansion and exchange rate volatility. To proceed with this, linear and nonlinear cointegration and Granger causality tests are applied in a bi-variate as well as in multivariate framework. The key message of the analysis is that there is a significant inflationary impact of capital inflows, in particular during the last 7 years. The finding suggest that there is a need to manage the capital inflows in such a way that they should neither create an inflationary pressure in the economy nor fuel the exchange rate volatility.

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Bibliographic Info

Paper provided by East Asian Bureau of Economic Research in its series Macroeconomics Working Papers with number 22832.

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Date of creation: Jan 2010
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Handle: RePEc:eab:macroe:22832

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Keywords: Capital Inflows; Inflationary Pressures; exchange rate volatility; Monetary Expansion; Nonlinear Dynamics;

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  1. Kyrtsou, Catherine & Labys, Walter C., 2007. "Detecting positive feedback in multivariate time series: The case of metal prices and US inflation," Physica A: Statistical Mechanics and its Applications, Elsevier, Elsevier, vol. 377(1), pages 227-229.
  2. Kwiatkowski, D. & Phillips, P.C.B. & Schmidt, P., 1990. "Testing the Null Hypothesis of Stationarity Against the Alternative of Unit Root : How Sure are we that Economic Time Series have a Unit Root?," Papers, Michigan State - Econometrics and Economic Theory 8905, Michigan State - Econometrics and Economic Theory.
  3. Renu Kohli, 2004. "Capital Account Liberalisation: Empirical Evidence and Policy Issues II," International Finance, EconWPA 0405009, EconWPA.
  4. Pami Dua & Partha Sen, 2006. "Capital Flow Volatility And Exchange Rates-- The Case Of India," Working papers 144, Centre for Development Economics, Delhi School of Economics.
  5. Rangan Gupta, 2005. "Financial Liberalization and Inflationary Dynamics," Working papers, University of Connecticut, Department of Economics 2005-31, University of Connecticut, Department of Economics.
  6. Orden, David & Fisher, Lance A, 1993. "Financial Deregulation and the Dynamics of Money, Prices, and Output in New Zealand and Australia," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 25(2), pages 273-92, May.
  7. Cook, David & Devereux, Michael B., 2006. "Capital inflows, fiscal discretion, and exchange rate policy," European Economic Review, Elsevier, Elsevier, vol. 50(8), pages 1975-1992, November.
  8. Dimitrios Hristu-Varsakelis & Catherine Kyrtsou, 2010. "Testing for Granger Causality in the Presence of Chaotic Dynamics," Brussels Economic Review, ULB -- Universite Libre de Bruxelles, vol. 53(2), pages 323-327.
  9. Kyrtsou, Catherine & Labys, Walter C., 2006. "Evidence for chaotic dependence between US inflation and commodity prices," Journal of Macroeconomics, Elsevier, Elsevier, vol. 28(1), pages 256-266, March.
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