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Why Should Emerging-Market Countries (Still) Concern Themselves With Capital Inflows?

  • Franklin Huaita
  • Manuel Agosín Trumper

This paper develops a simple analytic framework to analyze the effects of capital surges and sudden stops in the financial account of the balance of payments in emerging economies. In this model, capital inflows are largely exogenous to the recipient economies, they are very large when scaled to the size of the domestic financial sectors of recipients, and have large real effects. They also sow the seeds for the ensuing sudden stops, or capital flow reversals, observed in recent financial crises in emerging markets. Sudden stops can have devastating effects on output, growth, and employment. The paper goes on to test the main hypothesis derived from the model with an econometric analysis of capital surges and sudden stops using a panel-probit framework with heterogeneous unobserved country effects. While capital surges can be triggered by a number of domestic or foreign signals, the main variables that account for sudden stops are preceding capital surges, the size of the current account deficit, and contagion from sudden stops in other emerging markets. The main policy conclusion is that emerging economies need specific policies to deal with capital surges, which are largely exogenous to them.

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File URL: http://www.econ.uchile.cl/uploads/publicacion/a4794d4f-42dd-4e4c-9f92-906e6d1ae0cc.pdf
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Paper provided by University of Chile, Department of Economics in its series Working Papers with number wp268.

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Length: 44 pages
Date of creation: Nov 2007
Date of revision:
Handle: RePEc:udc:wpaper:wp268
Contact details of provider: Web page: http://www.econ.uchile.cl/

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  1. Barry J. Eichengreen & Poonam Gupta & Ashoka Mody, 2006. "Sudden Stops and IMF-Supported Programs," IMF Working Papers 06/101, International Monetary Fund.
  2. Fiess, Norbert, 2003. "Capital flows, country risk, and contagion," Policy Research Working Paper Series 2943, The World Bank.
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  4. Kaplan, Ethan & Rodrik, Dani, 2001. "Did the Malaysian Capital Controls Work?," Working Paper Series rwp01-008, Harvard University, John F. Kennedy School of Government.
  5. Manuel Agosin & Ricardo French-Davis, 1997. "Managing capital inflows in Chile," Estudios de Economia, University of Chile, Department of Economics, vol. 24(2 Year 19), pages 297-326, December.
  6. Robert J. Shiller, 2002. "From Efficient Market Theory to Behavioral Finance," Cowles Foundation Discussion Papers 1385, Cowles Foundation for Research in Economics, Yale University.
  7. Miguel Braun & Luciano Di Gresia, 2003. "Towards Effective Social Insurance in Latin America: The Importance of Countercyclical Fiscal Policy," IDB Publications (Working Papers) 6508, Inter-American Development Bank.
  8. Sebastian Edwards, 2005. "Capital Controls, Sudden Stops and Current Account Reversals," NBER Working Papers 11170, National Bureau of Economic Research, Inc.
  9. Guillermo Calvo & Alejandro Izquierdo & Luis-Fernando Mejía, 2004. "On the empirics of Sudden Stops: the relevance of balance-sheet effects," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  10. Jeffrey A. Frankel & Eduardo A. Cavallo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, Or Less? Using Gravity to Establish Causality," NBER Working Papers 10957, National Bureau of Economic Research, Inc.
  11. Sebastian Edwards & Roberto Rigobon, 2005. "Capital Controls, Exchange Rate Volatility and External Vulnerability," NBER Working Papers 11434, National Bureau of Economic Research, Inc.
  12. Jose De Gregorio & Sebastian Edwards & Rodrigo O. Valdes, 2000. "Controls on Capital Inflows: Do they Work?," NBER Working Papers 7645, National Bureau of Economic Research, Inc.
  13. Lukas Menkhoff & Mark P. Taylor, 2007. "The Obstinate Passion of Foreign Exchange Professionals: Technical Analysis," Journal of Economic Literature, American Economic Association, vol. 45(4), pages 936-972, December.
  14. Reinhart, Carmen & Calvo, Sara, 1996. "Capital Flows to Latin America: Is There Evidence of Contagion Effects?”," MPRA Paper 7124, University Library of Munich, Germany.
  15. Rodrigo O. Valdés & Leonardo Hernández & Pamela Melado, 2001. "Determinants of Private Capital Flows in the 1970's and 1990's; Is there Evidence of Contagion?," IMF Working Papers 01/64, International Monetary Fund.
  16. Edwards, Sebastian, 2007. "Capital controls, capital flow contractions, and macroeconomic vulnerability," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 814-840, September.
  17. Cardenas, Mauricio & Barrera, Felipe, 1997. "On the effectiveness of capital controls: The experience of Colombia during the 1990s," Journal of Development Economics, Elsevier, vol. 54(1), pages 27-57, October.
  18. Roberto Chang & Andrés Velasco, 2001. "A Model Of Financial Crises In Emerging Markets," The Quarterly Journal of Economics, MIT Press, vol. 116(2), pages 489-517, May.
  19. Kristin Forbes & Roberto Rigobon, 2000. "Contagion in Latin America: Definitions, Measurement, and Policy Implications," NBER Working Papers 7885, National Bureau of Economic Research, Inc.
  20. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  21. Paolo Mauro & Andrei A. Levchenko, 2006. "Do Some Forms of Financial Flows Help Protect From Sudden Stops?," IMF Working Papers 06/202, International Monetary Fund.
  22. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, vol. 49(6), pages 1603-1635, August.
  23. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
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