Pu blication - The great moderation in international capital flows: a global phenomenon? - By Peter McQuade, Martin Schmitz
Sources: IMF and ECB Balance of Payments Statistics; own calculations Notes: Foreign asset flows as percentages of global GDP
Non-technical summary
The global financial crisis in 2008 led to a precipitous decline in international capital flows, representing an abrupt interruption of the financial globalisation process. Our analysis in this paper starts from the observation that global capital flows have recovered somewhat in the ‘advanced’ post-crisis period, which we define as 2013-2014, but have settled at a far more moderate level compared to the pre-crisis period.
Moreover, the volatility of international capital flows has declined substantially in recent years, justifying the notion of a ‘great moderation’ in international capital flows. At the same time, the composition of global flows has changed substantially both in terms of the types of instruments as well as geographic composition. Compared to the pre-crisis period, global capital flows are now characterised by a persistently subdued level of crossborder banking flows and by a smaller share of flows to advanced economies, while capital now appears to exhibit a greater tendency to flow ‘downhill’ to lower income economies and foreign direct investment flows have gained in importance.
Our empirical analysis focuses on the substantial country heterogeneity in terms of the postcrisis recovery of capital flows by comparing the level of international capital flows observed in 2005-06, immediately prior to the onset of the global financial crisis, to the post-crisis period of 2013-14, when global flows arguably settled at a ‘new normal’. We find that since the precrisis period, gross capital inflows have recovered more for economies with smaller pre-crisis external and internal imbalances, as measured by net foreign liabilities as well as public and private debt.
Moreover, the recovery in inflows was more pronounced for economies with lower per capita income, improving growth expectations, a less severe impact of the global financial crisis and less stringent macroprudential policy. On the foreign asset side, countries with a more accommodative monetary policy, a milder impact of the crisis and oil exporters managed to increase gross capital outflows in the post-crisis period.
The cross-country results point to the exhaustion of some pre-crisis drivers of financial globalisation such as euro area financial integration and increasing balance sheets of financial institutions in advanced economies. Moreover, our results suggest that macroprudential policies could be impediments to international capital flows that may have permanent, in addition to short-term effects. Finally, we find a significant role for monetary policy as a driver of financial flows since the crisis, in particular on the asset side.
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