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Capital Inflows, Exchange Rate Flexibility, and Credit Booms

Author

Listed:
  • 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.

Suggested Citation

  • Nicolas E Magud & Esteban Vesperoni & Carmen Reinhart, 2012. "Capital Inflows, Exchange Rate Flexibility, and Credit Booms," IMF Working Papers 12/41, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:12/41
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    References listed on IDEAS

    as
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    Keywords

    Capital flows; Capital inflows; Bank credit; Domestic credit; Credit expansion; Exchange rate flexibility; Exchange rate regimes; Flexible exchange rates; foreign currency loans; financial regulation; exchange rate; exchange rate regime; Capital Inflows; Exchange Rate Flexibility; and Credit Booms; International Monetary Arrangements and Institutions; International Lending and Debt Problems;

    JEL classification:

    • F0 - International Economics - - General
    • F2 - International Economics - - International Factor Movements and International Business
    • F3 - International Economics - - International Finance
    • F62 - International Economics - - Economic Impacts of Globalization - - - Macroeconomic Impacts
    • G01 - Financial Economics - - General - - - Financial Crises
    • N25 - Economic History - - Financial Markets and Institutions - - - Asia including Middle East
    • N26 - Economic History - - Financial Markets and Institutions - - - Latin America; Caribbean

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