The Natural Level of Capital Flows

We put forward a theory-based time-varying supply-side measure of the natural level of capital flows, KF*. Out-of-sample empirical features of KF* are impressive. For countries that have quarterly time series data of capital flows, we show that KF* is a level to which flows converge in the medium term; greatly improves our ability to model notoriously volatile capital flows; and performs well against out-of-sample and in-sample filtering techniques. The gap between actual inflows and KF* also helps predict both 6-quarters ahead sudden stop episodes and medium-term equity returns. We close with how KF* and lessons from the global financial crisis help us think about capital flows during the Covid-19 shock.