Transcript Does Capital Mobility Finance or Cause a Current Account

Does Capital Mobility Finance
or Cause a Current Account
Imbalance?
Antonio H-D Yan
Universidad Francisco Marroquin
March 22, 2006
Two Hot Issues in the
International Economics
Free capital mobility: a blessing or a curse?
– Causes of capital mobility, “push” or “pull”
factor; policy response; sequences and paces
of financial liberalization.
Persistent current account deficit
– Recall the 1994-95 Mexican peso crisis, and
the 1997-98 Asian financial crisis: the collapse
of the pegged exchange rate regime;
inconsistent trinity; selection of exchange rate
regime.
Motivation
Haunted by Asian financial crises, an
increased concern about the
persistent and growing current
account deficit in the USA
Are capital inflows to the USA the
causes or consequences of the CA
deficits?
Richard Cooper (2001)
“The U.S. deficit is ‘financed’ by net
capital inflows only in an ex post
accounting sense. In economic terms
it is more nearly correct to say that
net capital inflows cause the current
account deficit.”
William Poole (2001)
“That many commentators have
expressed the mistaken view that
the capital and financial account
‘finances’ the current account. In fact,
for the United States, changes in the
capital and financial account have
been driving changes in the current
account for many years.”
The Purposes of This Paper
Show that developed countries and
developing countries are different on
the causality of the current account
and capital mobility
One of the differences is whether
the financial system is sophisticated
enough to absorb the inflowing
capitals
An Empirical Study
“If you torture the data long enough,
Nature will confess.” Ronald Coase
A job interview: Mathematician,
Statistician, and Econometrist.
Is Persistent Current Account
Deficit a Problem?
Yes: Corsetti, et al. (1999) and Edwards
(2002) for Developing Countries; Obstfeld
and Rogoff (2004) and Roubini and Setser
(2004) for the USA.
No: McKinnon (2001) and Mann (2002),
and Bernanke (2005).
Determinants of the CA
The factors of depth and
sophistication of the financial system
have a positive effect on the current
account for emerging economies,
while its effect is not significant for
developed countries. (Chinn and
Prasad, 2003)
How Current Account Imbalance
Adjusts?
Part of the business cycle for
developed countries, Freund (2000).
Emerging economies in the 1990s
reflect that a postponed current
account adjustment plays a central
role in dragging down the economy,
Edwards (2002).
Capital Inflow Overshooting and
Volatility
There is difference between trade in
widgets and dollars (Bhagwati, 1998)
absorptive capacity (Bacchante and
Wincoop, 2000)
BOP Accounting
0 = CA + FA + RES
= CA +(FDI +PI +OI)+RES
It is an identity and no causality
is implied.
How FA affects CA?
CA = S – I
= EX – IM
 release liquidity constraint (C up)
 real E appreciate, TB deficit
 real estate market boom (nontradable demand
up)
 FDI complements to I
 difference between short-run and long-run (policy
response)
Capital inflow: supply-pushed
How CA Affects FA?
High profit opportunity induced
capital inflow to finance domestic
investment, USA
CA surplus need to balance BOP,
Japan
Demand-induced capital inflow
Causal Relation: CA and FA
It is an empirical question
Different causal relation in the
current account and financial account
between emerging economies and
developed countries.
Developing countries are much more
vulnerable to free capital mobility.
Wong and Carranza (1999)
Four developing countries: Argentina,
Mexico, the Philippines, and Thailand
prior to 1989 (CA -> FA)
after 1989 (FA -> CA)
Empirical Methodology: Modified
Wald Test on Granger Causality
Dolado and Lütkepohl (1996) and
Toda and Yamamoda (1995)
Modified Wald test
The Augmented VAR
between CA and FA
CAt  1 
FAt   2 
m d max

i 1
1i
m  d max

i 1
2i
FAt i 
FAt i 
m  d max

i 1
1i
m  d max

i 1
2i
CAt i 
CAt i 
m  d max

i 1
1i
m  d max

i 1
2i
X t i 
X t i 
m  d max

i 1
m  d max

i 1
2i
1i
GDPt i V1t
GDPt i V2t
The null hypothesis of Granger noncausality from FA (CA) to CA (FA) is
= 0.
The Augmented VAR
between CA and FDI, PI, and OI

CAt  1 
m  d max

i 1
J  FDI , PI ,OI
FDI t   2 

m  d max
J  FDI , PI ,OI
PI t   3 

J  FDI , PI ,OI
OI t   4 

J  FDI , PI ,OI
J
1i

i 1
m  d max

i 1
m  d max

i 1
J t i 
J
2i
J
3i
J
4i
m  d max

i 1
J t i 
J t i 
J t i 
1i
CAt i 
m  d max

i 1
2i
m  d max

i 1
3i
m  d max

i 1
4i
CAt i 
CAt i 
CAt i 
m  d max

i 1
1i
m  d max

i 1
2i
m  d max

i 1
3i
m  d max

i 1
4i
X t i 
X t i 
X t i 
X t i 
m  d max

i 1
1i
m  d max

2i
i 1
m  d max

i 1
3i
m  d max

i 1
4i
GDPt i V1t
GDPt i V2t
GDPt i V3t
GDPt i V4t
Caveats of the Granger Causality
Reverse Causality: X’mas and X’mas
card (be cautious when interprets
the results)
Omitted variables: here X and GDP
Data
Developing countries: (1989.1-2003.4)
Argentina, Brazil, Indonesia, Mexico,
Philippines, South Korea, and Thailand
the G-7: (1974.1-2003.4)
Canada, France, Germany(1974.1-1989.4),
Italy, Japan, UK, and USA. (Kaminsky and
Schmukler, 2003)
CA, FA (FDI, PI, OI) in GDP ratio; and GDP
and real E in growth rate
Empirical Results (without
controlled variables)
CA and FA
Table 1a (developing countries)
Table 1b (G-7)
CA and FDI, PI and OI
Table 2a (developing countries)
Table 2b (G-7)
Empirical Results (with
controlled variables)
CA and FA
Table 3a (developing countries)
Table 3b (G-7)
CA and FDI, PI and OI
Table 4a (developing countries)
Table 4b (G-7)
Empirical Results (structural
break)
Tables 5a and 5b – developing
countries
Tables 6a and 6b – G-7
Conclusion (1)
For developed countries, capital mobility is
demand-induced and financial account
functions to finance current account.
For emerging economies, capital mobility
works like supply-pushed; the financial
account causes current account deficit.
For emerging economies (South Korea and
Thailand), other investment (bank loans)
brings to current account deficits.
Conclusion (2)
Without a sophisticated and sound
financial system should not
recklessly dismantle their restrictions
of capital mobility
The pace and sequence of
liberalization of the financial account
should be heeded also.
Extensions
Global savings glut: examining the
causality between FA with S and I
Using panel causality test to include more
countries and to have a more general
result. (Geweke, 1982 – simultaneous
causality)
Add the financial deepening variable in the
regression