Regulating Capital Flows to Emerging Markets: An Externality View
We show that capital flows to emerging market economies create externalities that differ by an order of magnitude depending on the state-contingent payoff profile of the flows. Those with pro-cyclical payoffs, such as foreign currency debt, generate substantial negative pecuniary externalities because they lead to large repayments and contractionary exchange rate depreciations during financial crises. Conversely, capital flows with an insurance component, such as FDI or equity, are largely benign. We construct an externality pricing kernel and use sufficient statistics and DSGE model simulations to quantify the externalities that materialized during past financial crises. We find stark differences depending on the payoff profile, justifying taxes of up to 3% for dollar debt but close to zero for FDI. These findings contrast with the existing literature, which has suggested that policymakers should focus on reducing over-borrowing rather than changing the composition of external liabilities.
The author would like to thank Viral Acharya, Julien Bengui, Javier Bianchi, Olivier Blanchard, Patrick Bolton, Alessandra Bonfiglioli, Phil Brock, Fernando Broner, Tiago Cavalcanti, Mick Devereux, Rex Ghosh, Gita Gopinath, Olivier Jeanne, Enrique Mendoza, Marcus Miller, Jonathan Ostry, Alessandro Rebucci, Carmen Reinhart, Joseph Stiglitz, Cédric Tille, Carlos Vegh, Iván Werning and Jianfeng Yu as well as participants at several conferences and seminars for helpful discussions and comments. I am also indebted to two anonymous referees and my editor, Charles Engel, who provided detailed comments on the manuscript. Financial support from INET/CIGI and from the IMF Research Fellowship is gratefully acknowledged. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
Anton Korinek, 2018. "Regulating Capital Flows to Emerging Markets: An Externality View," Journal of International Economics, Elsevier, vol 111, pages 61-80, March. citation courtesy of