The Effect of Capital Flows Composition on Output Volatility

A large literature has argued that different types of capital flows have different consequences for macroeconomic stability. By distinguishing between foreign direct investment and portfolio and other investments, this paper studies the effects of the composition of capital inflows on output volatility. The paper develops a simple empirical model which, under certain conditions that hold in the data, yields three key testable implications. First, output volatility should depend positively on the volatilities of both foreign direct investment and portfolio and other inflows. Second, output volatility should be an increasing function of the correlation between both kinds of inflows. Third, output volatility should be a decreasing function of the share of foreign direct investment in total capital inflows, for low values of that share. The data provide strong support for all three implications, even after controlling for other factors that may influence output volatility, and after dealing with potential endogeneity problems. These findings call attention to the importance of taking into account the synchronization and composition of capital flows for output stabilization purposes, as opposed to just focusing on the volatility of each component of capital flows.

Bibliographic Details

Main Authors:	Federico, Pablo, Vegh, Carlos A., Vuletin, Guillermo
Language:	English en_US
Published:	World Bank, Washington, DC 2013-03
Subjects:	ADVANCED ECONOMIES, AFFILIATED ORGANIZATIONS, AMERICAN DEVELOPMENT BANK, BENCHMARK, BOND, BUDGET CONSTRAINTS, CAPITAL ACCOUNT, CAPITAL CONTROLS, CAPITAL FLOWS, CAPITAL INFLOWS, CAPITAL STOCK, COMMODITY, COMMODITY PRICES, COST OF CAPITAL, COUNTRY RISK, CURRENCY, DATA AVAILABILITY, DEBT, DERIVATIVE, DERIVATIVES, DEVELOPING COUNTRIES, DEVELOPING COUNTRY, DEVELOPMENT ECONOMICS, DEVELOPMENT POLICY, DISCOUNTED VALUE, DIVIDENDS, DOMESTIC SAVING, DUMMY VARIABLE, ECONOMIC GROWTH, ECONOMIC INSTABILITY, ECONOMIC OUTLOOK, ECONOMIC RESEARCH, EMERGING ECONOMIES, EMERGING MARKET, EMERGING MARKET ECONOMIES, EMERGING MARKETS, EMPIRICAL GROWTH LITERATURE, EQUAL SHARE, EXPECTED VALUE, EXTERNAL FUNDING, EXTERNAL SHOCKS, FINANCIAL DEREGULATION, FISCAL POLICY, FOREIGN ASSETS, FOREIGN DIRECT INVESTMENT, FOREIGN DIRECT INVESTORS, FOREIGN INVESTORS, FOREIGN OWNERSHIP, FORMAL ANALYSIS, GOVERNMENT SPENDING, HIGHER VOLATILITY, HOLDING, INCOME, INDUSTRIAL COUNTRIES, INDUSTRIAL ECONOMIES, INSTRUMENT, INSTRUMENTAL VARIABLES, INSURANCE, INTERACTION TERMS, INTEREST RATES, INTERNATIONAL BANK, INTERNATIONAL CAPITAL, INTERNATIONAL COUNTRY RISK GUIDE, INTERNATIONAL ECONOMICS, INTERNATIONAL FINANCIAL STATISTICS, INTERNATIONAL INVESTORS, INTERNATIONAL SETTLEMENTS, INVESTMENT RISK, LENDERS, LOAN, LONG-TERM INTEREST, LONG-TERM INTEREST RATES, MACROECONOMIC POLICIES, MACROECONOMIC STABILITY, MACROECONOMIC VARIABLES, MACROECONOMICS, MARGINAL PRODUCTIVITY, NATIONAL BANK, NET FOREIGN ASSETS, OPEN ECONOMY, OUTPUT, OUTPUT VOLATILITY, OVERALL VOLATILITY, POLICY RESPONSE, PORTFOLIO, PORTFOLIO CAPITAL, PORTFOLIO DEBT, PORTFOLIO INVESTMENT, PORTFOLIO THEORY, PRIVATE CAPITAL, PRIVATE CAPITAL FLOWS, PRODUCTION FUNCTION, REAL GDP, REPAYMENT, REPAYMENT OF PRINCIPAL, REVIEW OF ECONOMICS, RISK SHARING, SAVINGS, SHORT-TERM BORROWING, STANDARD DEVIATION, STANDARD ERRORS, TRADE CREDITS, VOLATILE ECONOMIES, VOLATILITIES, VOLATILITY, VOLATILITY MEASURES, WEALTH, WORLD MARKET, WORLD MARKET INTEGRATION,
Online Access:	http://documents.worldbank.org/curated/en/2013/03/17458211/effect-capital-flows-composition-output-volatility https://hdl.handle.net/10986/13184
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