International Capital Mobility Chapter 6

Outline 1.Indicators of the degree of international capital mobility (ICM) 2.Recent increase in ICM 3.Differences between net and gross capital flows 4.Differences between capital flows and capital stocks 5.Costs and benefits of ICM  Loss of policy autonomy

Current account balance as indicator of the degree of ICM Current account surplus ≡ Net capital outflow Current account balance = S – I (National savings S = private plus public savings)  In discussing ICM we have to distinguish between private and public capital flows. In the absence of ICM, I must equal S (constraint on the economy) Relaxing this constraint is one of the two main potential gains from ICM! Table 6.1 and Fig. 6.1.

© van Marrewijk, 2005 Figure 6.1

CA balance as indicator of ICM: Major findings : High degree of ICM. Inter-war and post WWII-1973: A decline in international capital flows. ICM began again to increase only recently. The size of net international capital flows is still lower relative to Table 6.1 and Fig. 6.1 undermine the argument that a major characteristic of the global economy is a high and growing degree of ICM. The argument seems to hold only if we compare post 1973 data to the early decades after WWII. Fig. 6.2.

© van Marrewijk, 2005 Figure 6.2

Conceptual Issues What is the direction (and size) of capital flows to developing countries? Net capital flows to emerging markets (Table 6.2) High volatility and sharp reversals (Fig. 6.3) FDI versus portfolio investment

© van Marrewijk, 2005 Source: IMF (2000). Figure 6.3

Measuring ICM: Major Issues 1.International mobility versus international capital integration 2.Capital stocks versus capital flows 3.Net capital mobility versus gross capital mobility 4.The composition of capital flows 5.Price versus quantity

What can international capital mobility tell us about international capital integration? Not much. Capital flows: Cover only financial transactions between residents and non- residents that take place within a specified period of time. No information on the stock of international financial assets and liabilities. (Table 6.3 and Fig. 6.4)

© van Marrewijk, 2005 Source: see Table 6.3 Figure 6.4

Gross capital mobility versus net capital mobility The importance of gross financial stocks Foreign asset/GDP ratio and foreign liabilities/GDP ratio (Table 6.4 and Fig. 6.5)

© van Marrewijk, 2005 Source: see Table 6.4 Figure 6.5

Composition of capital flows Time horizon of the financial asset: Short- term or long-term? (Study by Obstfeld and Taylor, 2004 – see page 173)

Prices vs. quantities The current account balance data provide no information on prices With a high degree of capital account integration, prices become similar across countries (e.g., interest rates) r home = r foreign + risk + TC ( eq. 6.1) r home = r foreign + dE (TC = 0; risk = dE) (eq. 6.1´) We can rewrite eq. 6.1´ as i home - i foreign = dE+ (π home - π foreign ) Interest rate differentials (Fig. 6.6)

© van Marrewijk, 2005 Source: Obstfeld (1998) Figure 6.6

Determinants, benefits and costs of ICM  Three explanations of the rise of ICM in the 19 th and early 20 th century. Technology Role of financial institutions Role of politics (most important explanation)  The spider web spiral (Fig. 6.7)

© van Marrewijk, 2005 Source: League of Nations (1933). Values in January ( ): 2998, 2739, 1839, 1206, and 992 Figure 6.7

Summary Benefits (chap. 7) Disentangling of national savings and investment Reduction of the risk involved in financial transactions Costs Limitation of national policy autonomy Increase of financial fragility (chap. 9) and the role of currency instability in financial fragility

Policy independence Loss of policy autonomy Three policy objectives: 1.Fixed exchange rate 2.Monetary policy independence 3.Capital mobility r home = r foreign + dE+ TC (eq. 6.1´´)

© van Marrewijk, 2005 Figure 6.8

 Is the trilemma for real?  Empirical evidence (Table 6.5)  From a trilemma to a dilemma?  Location competition and capital mobility  Box 6.2