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

  • Frankel, Jeffrey A
  • Okongwu, Chudozie

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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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. Kenneth A. Froot and Jeffrey A. Frankel., 1988. "Forward Discount Bias: Is It an Exchange Risk Premium?," Economics Working Papers 8874, University of California at Berkeley.
  2. 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.
  3. Guillermo A. Calvo, 1991. "The Perils of Sterilization," IMF Staff Papers, Palgrave Macmillan, vol. 38(4), pages 921-926, December.
  4. Menzie Chinn & Jeffrey Frankel, 1991. "Patterns in Exchange Rate Forecasts for 25 Currencies," NBER Working Papers 3807, National Bureau of Economic Research, Inc.
  5. 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.
  6. 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.
  7. Vittorio Grilli & Gian-Maria Milesi-Ferretti, 1995. "Economic Effects and Structural Determinants of Capital Controls," IMF Working Papers 95/31, International Monetary Fund.
  8. Carmen M. Reinhart & Sara Calvo, 1996. "Capital Flows to Latin America: Is There Evidence of Contagion Effects?," Peterson Institute Press: Chapters, in: Guillermo A. Calvo & Morris Goldstein & Eduard Hochreiter (ed.), Private Capital Flows to Emerging Markets After the Mexican Crisis, pages 151-171 Peterson Institute for International Economics.
  9. Leonardo Leiderman & Guillermo A. Calvo & Carmen Reinhart, 1994. "Inflows of Capital to Developing Countries in the 1990s: Causes and Effects," Research Department Publications 4002, Inter-American Development Bank, Research Department.
  10. 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.
  11. 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.
  12. 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.
  13. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1994. "Capital Inflows to Latin America: The 1970s and 1990s," MPRA Paper 8196, University Library of Munich, Germany.
  14. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1994. "The Capital Inflows Problem: Concepts And Issues," Contemporary Economic Policy, Western Economic Association International, vol. 12(3), pages 54-66, 07.
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