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Are Capital Inflows Expansionary or Contractionary? Theory, Policy Implications, and Some Evidence

Author

Listed:
  • Olivier Blanchard

    (Peterson Institute for International Economics)

  • Jonathan D. Ostry

    (International Monetary Fund)

  • Atish R. Ghosh

    (International Monetary Fund)

  • Marcos Chamon

    (International Monetary Fund)

Abstract

The workhorse open economy macromodel suggests that capital inflows are contractionary because they appreciate the currency and reduce net exports. Emerging market policy makers, however, believe that inflows lead to credit booms and rising output, and the evidence appears to go their way. To reconcile theory and reality, we extend the set of assets included in the Mundell–Fleming model to include both bonds and non-bonds. At a given policy rate, inflows may decrease the rate on non-bonds, reducing the cost of financial intermediation, potentially offsetting the contractionary impact of appreciation. We explore the implications theoretically and empirically and find support for the key predictions in the data.

Suggested Citation

  • Olivier Blanchard & Jonathan D. Ostry & Atish R. Ghosh & Marcos Chamon, 2017. "Are Capital Inflows Expansionary or Contractionary? Theory, Policy Implications, and Some Evidence," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 65(3), pages 563-585, August.
    • Handle: RePEc:pal:imfecr:v:65:y:2017:i:3:d:10.1057_s41308-017-0039-z
    DOI: 10.1057/s41308-017-0039-z
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    More about this item

    Keywords

    F31; F32;

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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