The temporal dimensions of policy responses to capital surges

Abstract

AbstractWe demonstrate that country-specific conditions and policies that can help manage the risks of excessive capital flows behave differently over time. Employing instrumental variable quantile regression estimates, our empirical methodology scrutinizes the projected distribution of portfolio inflows to emerging markets after an adverse international financial shock. This method enables us to differentiate the efficacy of policies and country-specific conditions in both the short and medium term. In the wake of a negative shock, our findings indicate that implementing more stringent capital controls is likely detrimental. In contrast, foreign exchange interventions and macroprudential policies prove beneficial in mitigating the risks associated with excessive inflows in the short and medium term. Notably, monetary policy cannot insulate economies from the risks of substantial capital inflows in the short or medium term. Furthermore, while institutional quality does not influence the risks in the short term, it can potentially reduce them in the medium term. We underscore the intertemporal tradeoffs associated with these policies, highlighting an aspect not considered in previous studies, which predominantly focused on the short-term impact.Keywords: Policy interventioncountry-specific conditionsfinancial shocks Disclosure statementNo potential conflict of interest was reported by the author(s).Data availability statementData available on request due to privacy/ethical restrictions.Notes1 The short term refers to a period of two quarters, and the meduim term to eight quarters.2 We build on Ben Zeev (Citation2017) by assuming identical quarterly values equal to the corresponding annual values to transform annual capital control data into quarterly frequency. This assumption is strong, particularly for capital control indexes for which Fernández et al. (Citation2016) argue that these controls vary little over a year, have low standard deviations, and are highly acyclical in nature.3 Chinn and Ito (Citation2008) and Fernández et al. (Citation2016) indices capture “intensity” in the sense of how comprehensively capital flows are restricted. Besides, aggregate indices of capital controls may reflect a form of intensity of restrictions on capital movements across borders. For instance, Fernández et al. (Citation2016) show that an aggregate index of controls on capital inflows captures the evolution of actual tax rates on capital inflows in the emblematic case of Brazil in the late 2000s. Then, our conclusion continues to hold although that Chinn and Ito (Citation2008) and Fernández et al. (Citation2016) are ‘de jure’ indices.Additional informationFundingThis study is supported via funding from Prince Sattam bin Abdulaziz University project number [PSAU/2023/R/1444].