Capital Inflows, Exchange Rate Flexibility, and Credit Booms

By Nicolas E Magud, Esteban Vesperoni, Carmen Reinhart

February 1, 2012

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Nicolas E Magud, Esteban Vesperoni, and Carmen Reinhart. Capital Inflows, Exchange Rate Flexibility, and Credit Booms, (USA: International Monetary Fund, 2012) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Balance of payments, Capital inflows, Currencies, Domestic credit, Exchange rate arrangements, Exchange rate flexibility, Foreign exchange, Money

Keywords: Asia and Pacific, Capital flow, Capital inflows, Credit, Credit composition, Credit multiplier, Currencies, Domestic credit, Europe, Exchange rate, Exchange rate arrangements, Exchange rate flexibility, Exchange rate regime, Financial regulation, Foreign currency loans, WP

Publication Details

Pages:

24
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2012/041
Stock No:

WPIEA2012041
ISBN:

9781463936426
ISSN:

1018-5941

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