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Capital Inflows, Exchange Rate Flexibility, and Credit Booms

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  • Nicolas E. Magud
  • Esteban Vesperoni
  • Carmen Reinhart

Abstract

The prospects of expansionary monetary policies in the advanced countries for the foreseeable future have renewed the debate over policy options to cope with large capital inflows that are, at least partly, driven by low interest rates in the financial centers. Historically, capital flow bonanzas have often fueled sharp credit expansions in advanced and emerging market economies alike. Focusing primarily on emerging markets, we analyze the impact of exchange rate flexibility on credit markets during periods of large capital inflows. We show that bank credit grows more rapidly and its composition tilts to foreign currency in economies with less flexible exchange rate regimes, and that these results are not explained entirely by the fact that the latter attract more capital inflows than economies with more flexible regimes. Our findings thus suggest countries with less flexible exchange rate regimes may stand to benefit the most from regulatory policies that reduce banks'' incentives to tap external markets and to lend/borrow in foreign currency; these policies include marginal reserve requirements on foreign lending, currency-dependent liquidity requirements, and higher capital requirement and/or dynamic provisioning on foreign exchange loans.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/41.

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Length: 24
Date of creation: 01 Feb 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/41

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Keywords: Capital inflows; Bank credit; Capital flows; Credit expansion; Exchange rate regimes; Flexible exchange rates; exchange rate; domestic credit; exchange rate regime; exchange rate flexibility; flexible exchange rate regimes; flexible exchange rate; capital flow; fixed exchange rate; capital controls; exchange rate arrangements; exchange rates; inflexible exchange rate regimes; capital requirement; foreign exchange; exchange rate volatility; nominal exchange rate; capital flows reversals; inflexible exchange rate; gross domestic product; floating exchange rate regime; alternative exchange rate regimes; domestic bonds; exchange restrictions; fixed exchange rate regime; alternative exchange rate; real effective exchange rate; foreign investment; capital markets; capital flow reversals; exchange arrangements; capital movements; international capital markets; capital inflow; fixed exchange rate regimes; exchange rate classification; external capital; international capital; stock market capitalization; currency risk; debt stock; credible fixed exchange rate regime; exchange rate stability; effective exchange rate; nominal exchange rate stability; exchange rate level; floating exchange rates; open market sales; exchange rate overshooting; real exchange rate; short-term capital; stock market; floating exchange rate; intermediate regimes; history of exchange rate;

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References

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  1. Atish R. Ghosh & Jonathan David Ostry & Charalambos G. Tsangarides, 2011. "Exchange Rate Regimes and the Stability of the International Monetary System," IMF Occasional Papers 270, International Monetary Fund.
  2. Carmen M. Reinhart & Vincent R. Reinhart, 2008. "Capital Flow Bonanzas: An Encompassing View of the Past and Present," NBER Working Papers 14321, National Bureau of Economic Research, Inc.
  3. Nicolas E. Magud & Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "Capital Controls: Myth and Reality - A Portfolio Balance Approach," NBER Working Papers 16805, National Bureau of Economic Research, Inc.
  4. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 1-48, February.
  5. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  6. International Monetary Fund, 2011. "Macroprudential Policy," IMF Working Papers 11/238, International Monetary Fund.
  7. Fernandez-Arias, Eduardo & Montiel, Peter J, 1996. "The Surge in Capital Inflows to Developing Countries: An Analytical Overview," World Bank Economic Review, World Bank Group, vol. 10(1), pages 51-77, January.
  8. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Vegh, 2004. "When it Rains, it Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Working Papers 10780, National Bureau of Economic Research, Inc.
  9. Enrique G. Mendoza & Marco E. Terrones, 2008. "An Anatomy Of Credit Booms: Evidence From Macro Aggregates And Micro Data," NBER Working Papers 14049, National Bureau of Economic Research, Inc.
  10. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc.
  11. Gourinchas, Pierre-Olivier & Obstfeld, Maurice, 2011. "Stories of the Twentieth Century for the Twenty-First," CEPR Discussion Papers 8518, C.E.P.R. Discussion Papers.
  12. Atish R. Ghosh & Anne-Marie Gulde & Holger C. Wolf, 2003. "Exchange Rate Regimes: Choices and Consequences," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262072408, December.
  13. International Monetary Fund, 2011. "Policy Instruments to Lean Against the Wind in Latin America," IMF Working Papers 11/159, International Monetary Fund.
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Citations

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Cited by:
  1. Stijn Claessens & M. Ayhan Kose, 2013. "Financial Crises Explanations, Types, and Implications," IMF Working Papers 13/28, International Monetary Fund.
  2. Castroa, Vitor & Kubota, Megumi, 2013. "Duration dependence and change-points in the likelihood of credit booms ending," Policy Research Working Paper Series 6475, The World Bank.
  3. Atish R. Ghosh & Jonathan David Ostry & Mahvash Saeed Qureshi, 2014. "Exchange Rate Management and Crisis Susceptibility: A Reassessment," IMF Working Papers 14/11, International Monetary Fund.
  4. Gozgor, Giray, 2014. "Determinants of domestic credit levels in emerging markets: The role of external factors," Emerging Markets Review, Elsevier, vol. 18(C), pages 1-18.
  5. Reinhart, Carmen, 2012. "Capital Inflows, Credit Booms and Their Risks," MPRA Paper 50981, University Library of Munich, Germany.
  6. Reinout De Bock & Alexander Demyanets, 2012. "Bank Asset Quality in Emerging Markets," IMF Working Papers 12/71, International Monetary Fund.
  7. Calderon, Cesar & Kubota, Megumi, 2012. "Gross inflows gone wild : gross capital inflows, credit booms and crises," Policy Research Working Paper Series 6270, The World Bank.
  8. Stefan Avdjiev & Robert McCauley & Patrick McGuire, 2012. "Rapid credit growth and international credit: Challenges for Asia," BIS Working Papers 377, Bank for International Settlements.
  9. Enrique G. Mendoza & Marco E. Terrones, 2012. "An Anatomy of Credit Booms and their Demise," NBER Working Papers 18379, National Bureau of Economic Research, Inc.
  10. Marco Terrones & Enrique Mendoza, 2013. "Anatomy of credit booms and their demise," 2013 Meeting Papers 649, Society for Economic Dynamics.
  11. Eduardo Olaberría, 2012. "Capital Inflows and Booms in Assets Prices: Evidence From a Panel of Countries," Working Papers Central Bank of Chile 675, Central Bank of Chile.
  12. Nicolas E. Magud & Evridiki Tsounta, 2012. "To Cut or Not to Cut? That is the (Central Bank’s) Question In Search of the Neutral Interest Rate in Latin America," IMF Working Papers 12/243, International Monetary Fund.
  13. Gregorio Impavido & Heinz Rudolph & Luigi Ruggerone, 2013. "Bank Funding in Central, Eastern and South Eastern Europe Post Lehman," IMF Working Papers 13/148, International Monetary Fund.

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