Emerging market capital flows and U.S. monetary policy

• Date: 01 March 2020
• DOI: http://doi.org/10.1111/infi.12355
• Author: Steven B. Kamin,John Clark,Nathan Converse,Brahima Coulibaly
• Published date: 01 March 2020

© Published 2019. This article is a U.S. Government work and is in the public domain in the USA

International Finance. 2020;23:2–17.2

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wileyonlinelibrary.com/journal/infi

DOI: 10.1111/infi.12355

ORIGINAL ARTICLE

Emerging market capital flows and U.S.

monetary policy

John Clark

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Nathan Converse

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Brahima Coulibaly

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Steven B. Kamin

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Markets Group, The Federal Reserve

Bank of New York, New York, New York

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Division of International Finance, The

Federal Reserve Board, Washington,

District of Columbia

Correspondence

Nathan Converse, The Federal Reserve

Board, 20th and C Streets NW,

Washington, D.C. 20551

Email: Nathan.l.converse@frb.gov

Abstract

This paper analyzes the drivers of net private capital

flows to emerging market economies (EMEs), focusing

in particular on the policies of the Federal Reserve. We

argue that the role of the Federal Reserve in EME capital

flows has been smaller than popularly believed. We first

show that the run‐up in capital flows to EMEs predated

the loosening of Fed policy, while flows slowed

substantially between 2010 and 2015, even as the Fedʼs

quantitative easing program continued to add to

monetary stimulus. Both the initial surge in capital

flows to EMEs and their subsequent decline are better

explained by swings in commodity prices and EME

output growth, a linkage which we confirm through

panel data regressions on capital flows to 20 major

EMEs. The anticipation of the normalization of Federal

Reserve policy appears not to have played a predomi-

nant role in the decline of capital flows to EME between

2010 and 2015.

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INTRODUCTION

The years 2009–2011, immediately following the global financial crisis (GFC), were marked by a

surge in capital flows to emerging market economies (EMEs) that coincided with the aggressive

loosening of monetary policy in advanced economies. These simultaneous developments led

many observers to conclude that the highly accommodative policies of the Federal Reserve and

other advanced economy central banks were what triggered the wave of capital flows toward

EMEs. Observers expressed concerns that these flows posed a policy challenge for the recipient

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economies, contributing to excessive credit growth, creating the risk of asset price bubbles, and

causing unwanted exchange‐rate appreciation. Some characterized the advanced‐economy

monetary policies as “currency wars,”arguing that the policies targeted weaker exchange rates

to gain a competitive advantage.

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Concerns were also raised that once monetary policy in the

United States and other advanced economies began to normalize, these flows would reverse,

slowing growth and creating additional complications and disruptions in EMEs.

In this paper, we analyze the role played by the policies of the Federal Reserve in the

evolution of capital flows to EMEs. In particular, we put forward several arguments suggesting

that this role has been smaller than popularly believed. As we document below, capital flows to

EMEs had actually started their surge in the mid‐2000s, well before the GFC and resultant

loosening of advanced‐economy monetary policies; the surge in capital flows during 2009–2011

in large part reflected a bounceback from the temporary collapse in these flows that occurred

during the GFC. Even more important, after 2010 capital flows to EMEs started to ratchet down,

even as monetary policies in the United States and other advanced economies continued to

loosen. These considerations suggest that, while advanced‐economy monetary policy likely

influenced EME capital flows in the post‐GFC period, they were not the predominant driver of

these flows.

These considerations also raise the question of why EME capital flows receded between 2011

and 2015. Accordingly, in this paper we analyze the drivers of EME capital flows, focusing in

particular on the role of U.S. monetary policy and other potential factors in the decline in

capital flows to EMEs since 2010. Our findings suggest that this decline was mainly an

endogenous response to waning EME output growth relative to growth in advanced economies

and also to weakening commodity prices.

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The anticipation of the normalization of Federal

Reserve policy, including during the so‐called taper tantrum when market participants shifted

their expectations about the outlook for U.S. monetary policy in 2013, appears not to have

played a predominant role. Increased concerns about EME creditworthiness, which would be

expected to generate a widening in credit spreads, also appear to have played only a secondary

role in the decline in capital flows. Consistent with this finding, the period from 2011 to 2015

saw few EME financial crises, which stands in stark contrast to the widespread surges in credit

spreads and financial turbulence that brought previous EME credit and economic expansions to

an end.

This paper contributes to two separate but related areas of literature. First, this paper builds

on research on the drivers of capital flows to EMEs, where a prominent theme has been the

relative role of global push factors relative to local pull factors (Forbes & Warnock, 2012).

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Early

work in this area found an important role for U.S. interest rates in rates in driving flows, but

also highlighted the role of growth differentials (Calvo, Leiderman, & Reinhart, 1993) and

investor perceptions of EME risk (Chuhan, Claessens, & Mamingi, 1998). More recent work has

studied how the relative importance of push and pull factors vary depending on country

characteristics (Cerutti, Claessens, & Puy, 2019; Fratzscher, 2012) and over time (Ahmed &

Zlate, 2014). We adapt the empirical methodology developed in these papers to assess the role of

one particular global push factor, U.S. monetary policy, in driving flows during the period

between the GFC and 2015.

This paper also contributes to a second, recent area of research that focuses specifically on the

spillovers to EMEs from advanced economies’monetary policies, with a particular focus on

unconventional policy. This body of work has documented the channels through which

conventional U.S. monetary policy affects bank lending to EMEs (Bruno & Shin, 2015) and has

quantified the impacts of unconventional monetary policy (Chen, Filardo, He, & Zhu, 2012;

CLARK ET AL.

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