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Capital Inflows, Exchange Rate Flexibility and Credit Booms

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  • Nicolas E. Magud
  • Carmen M. Reinhart
  • Esteban R. Vesperoni

Abstract

Historically, capital flow bonanzas have often fueled sharp credit expansions in advanced and emerging market economies alike. Focusing primarily on emerging markets, this paper analyzes the impact of exchange rate flexibility on credit markets during periods of large capital inflows. It is shown that bank credit is larger 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. The 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.

Suggested Citation

  • Nicolas E. Magud & Carmen M. Reinhart & Esteban R. Vesperoni, 2014. "Capital Inflows, Exchange Rate Flexibility and Credit Booms," Review of Development Economics, Wiley Blackwell, vol. 18(3), pages 415-430, August.
  • Handle: RePEc:bla:rdevec:v:18:y:2014:i:3:p:415-430
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    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F2 - International Economics - - International Factor Movements and International Business
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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