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

Author

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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.

Suggested Citation

  • Abdul Rashid & Fazal Husain, 2010. "Capital Inflows, Inflation and Exchange Rate Volatility : An Investigation for Linear and Nonlinear Causal Linkages," Macroeconomics Working Papers 22832, East Asian Bureau of Economic Research.
  • Handle: RePEc:eab:macroe:22832
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    References listed on IDEAS

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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, vol. 377(1), pages 227-229.
    2. Cook, David & Devereux, Michael B., 2006. "Capital inflows, fiscal discretion, and exchange rate policy," European Economic Review, Elsevier, vol. 50(8), pages 1975-1992, November.
    3. Kyrtsou, Catherine & Labys, Walter C., 2006. "Evidence for chaotic dependence between US inflation and commodity prices," Journal of Macroeconomics, Elsevier, vol. 28(1), pages 256-266, March.
    4. Kwiatkowski, Denis & Phillips, Peter C. B. & Schmidt, Peter & Shin, Yongcheol, 1992. "Testing the null hypothesis of stationarity against the alternative of a unit root : How sure are we that economic time series have a unit root?," Journal of Econometrics, Elsevier, vol. 54(1-3), pages 159-178.
    5. 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.
    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, vol. 25(2), pages 273-292, May.
    7. Renu Kohli, 2004. "Capital Account Liberalisation: Empirical Evidence and Policy Issues II," International Finance 0405009, EconWPA.
    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. Rangan Gupta, 2005. "Financial Liberalization and Inflationary Dynamics," Working papers 2005-31, University of Connecticut, Department of Economics.
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    Citations

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    Cited by:

    1. Raza, Syed Ali & Sabir, Muhammad Sarwar & Mehboob, Farhan, 2011. "Capital inflows and economic growth in Pakistan," MPRA Paper 36790, University Library of Munich, Germany.
    2. Roy, Ripon & Rahman, Md. Mokhlesur, 2014. "An empirical analysis of remittance – inflation relationship in Bangladesh: post-floating exchange rate scenario," MPRA Paper 55190, University Library of Munich, Germany.

    More about this item

    Keywords

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

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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