Magud, N. & Vesperoni, R. E. (2014) Exchange-rate flexibility and credit during capital inflow deversals: Purgatory… not paradise, VoxEU Organisation, 30 May.
Expansionary monetary policy in advanced economies have created capital inflow booms in emerging markets. This column analyses the effect of exchange rate flexibility on credit markets during capital inflow booms. In economies with less flexible exchange rate regimes, credit grows faster and more towards foreign currency. These countries may benefit the most from regulatory policies.
Large capital inflows usually have an important impact on macroeconomic conditions – and in particular, on fluctuations in domestic credit (Mendoza and Terrones 2012). Capital inflow booms can finance investment and economic growth, and can also bolster the deepening of what are often shallow financial sectors. Banking sector credit usually expands and stimulates consumption. The volatility associated with these cycles may pose significant macroeconomic challenges. Reversals in capital inflows could potentially result in credit busts and asset price deflation, with devastating effects on the macroeconomy. Notably, the recent fluctuations in global risk aversion triggered by the Federal Reserve ‘tapering’ talk in 2013 are a reminder of the likelihood of reversals in large capital inflows. Consequently, these events strengthen the need for a proper debate over the policy framework and the corresponding policy mix needed to deal with large fluctuations in international capital flows. In a recent paper we tackle some of these issues (Magud and Vesperoni 2014).
Relevant posts:
- Schadler, S. (2014) “The IMF’s preferred creditor status: Questions after the Eurozone crisis”, VoxEU Organisation, 28 April.
- Baldacci, E., Gupta, S., Mulas-Granados, C. (2014) “Fiscal adjustment and growth: Beware of the credit constraints“, VoxEU Organisation, 31 March.
- Wickens, M. and Polito, V. (2013) “A fiscal perspective on EU sovereign credit ratings: Did the credit-rating agencies get them right?“, VoxEU Organisation, 30 October.