Essays on International Capital Flows and Management in Emerging Market Economies

Abstract

In this dissertation, I study international capital flows with a focus on capital flow management measures (CFMs) in emerging market economies (EMEs). In Chapter 1, I explain the mechanism of CFMs with optimal tax rates by incorporating the significant increase of gross outflows in EMEs. I construct a simple three-period model of pecuniary externalities where private domestic agents do not consider the effect of borrowing or overseas investment decision on their own financial constraint. The model differs from previous efforts in that it explicitly differentiates gross inflows (i.e., borrowing from foreign investors) from gross outflows (i.e., overseas investment in foreign assets) to reflect the larger role of gross outflows in EMEs. I show that the optimal tax rate on gross inflows is 0.8%p higher when foreign assets are included in the model, which is due to greater unintended side effects of borrowing through the channel of foreign asset prices. The findings generalize previous models by illustrating how externalities can be corrected with Pigouvian tax on borrowing as well as subsidy on overseas investment. This study also provides new policy insights into CFMs by suggesting separate management of gross inflows and outflows. In Chapter 2, I seek greater insight into the evaluation of CFMs by investigating their impact on income inequality in a small open economy. I focus on the long-term effect of capital flow liberalization on capital income ratio between households and entrepreneurs. Going a step further from the existing model that assumes risk premium of entrepreneurs’ external borrowing, I assume that households acknowledge a discount on the returns from their investments in foreign assets, which allows consideration of additional factors such as international transaction costs. According to the findings of this study, capital liberalization of gross inflows and outflows can have opposite impacts on income inequality through returns to capital and savings. Contrary to liberalizing gross outflows of households, liberalizing entrepreneurs’ external borrowing (i.e., gross inflows) can contribute to the increase of income inequality. This indicates that managing gross inflows can have a positive distributional effect in the long term, which provides further theoretical understanding of CFMs. In Chapter 3, we conduct an empirical study to assess the effectiveness of CFMs in curbing the capital flows’ fluctuations in EMEs caused by monetary policy shocks. In particular, we examine i) the extent to which CFMs mitigate the impact of US monetary shocks and ii) whether the mitigating effect differs between net capital flows and gross capital flows. Our results, based on a local projection panel estimation for the period 2000-2018, indicate that CFMs effectively reduce the fluctuations of both gross capital inflows and outflows when there are monetary policy shocks from the US. Our findings also show that the effect is more pronounced when we check in gross flows rather than net. In contrast to the effects in gross flows, the mitigating effects on net flows are ambiguous in most specifications.