Capital Controls and the Real Exchange Rate: Do Controls Promote Disequilibria? [new draft!]
The consensus view is that capital controls can effectively lengthen the maturity composition of capital inflows and increase the independence of monetary policy but are not generally effective at reducing net inflows and influencing the real exchange rate. This paper studies the adjustment dynamics of the real exchange rate towards its long-run equilibrium and presents empirical evidence that capital controls increase the persistence of misalignments. Allowing the speed of adjustment to vary according to the intensity of restrictions on capital flows, it is shown that the real exchange rate converges to its long-run level at significantly slower rates in countries with capital controls. This result is strongest when the exchange rate is undervalued and appears to operate primarily via nominal exchange rate dynamics. In addition, controls on capital inflows have consistently greater effects than controls on outflows. The results also suggest that flexible exchange rate regimes accelerate the adjustment of disequilibria relative to managed and fixed regimes.
Did Quantitative Easing Increase Income Inequality? (with Gerald Epstein) [new draft!]
(INET Working Paper No. 28)
The impact of the post-crisis Federal Reserve policy of near-zero interest rates and Quantitative Easing (QE) on income and wealth inequality has become an important policy and political issue. Critics have argued that by raising asset prices, near-zero interest rates and QE have significantly contributed to increases in inequality, while practitioners of central banking, counter that the distributional impact have probably been either neutral or even egalitarian in nature due to its employment impacts. Yet there has been little academic research that addresses empirically this important question. We use data from the Federal Reserve’s Survey of Consumer Finances to analyze the impact of three key channels of QE policy on the distribution of income: 1) the employment channel, 2) the asset appreciation and return channel, and 3) the mortgage refinancing channel. Applying the distributional decomposition method proposed by Firpo et al. (2007), we find that while employment changes and mortgage refinancing were equalizing, these impacts were nonetheless swamped by the large dis-equalizing effects of asset appreciations. In order to identify causality, we propose a simple counterfactual exercise building on the extensive literature on the macroeconomic impacts of QE on asset prices and the unemployment rate. We conclude that QE likely led to a modest increase in income inequality.
Sustained Investment Surges (with Emiliano Libman and Arslan Razmi) [new draft!]
Existing empirical studies have focused on determinants of investment. We focus instead on the factors promoting episodes of accelerated capital stock growth that last seven years or longer. After identifying 190 such episodes we employ econometric analysis to explore: (i) the conditions that precede episodes, (ii) structural changes during episodes, and (iii) the characteristics that distinguish episodes that are sustained beyond the final year from those that are not. Turning points in investment tend to be preceded by stable and undervalued real exchange rates, low inflation, and net capital outflows, especially on the portfolio account. We also find some evidence for a positive correlation with large increases in natural resource rents and trade openness. Finally, we find that economies typically experience a shift in economic structure toward the manufacturing sector during periods of accelerated investment.
Leaky Capital Controls in the Presence of Savvy Financial Markets [email me for a draft]
This paper studies the social welfare implications of capital controls when controls are imperfectly binding and financial markets actively aim to bypass their enforcement. I consider a series of models of a small open economy featuring a “Dutch disease” externality arising from excessive capital inflows, as well as strategic interactions between a regulatory authority attempting to enforce capital controls and a financial sector attempting to evade them. In contrast to most existing theoretical models, which assume perfectly enforceable capital controls, the effective tax on capital inflows in this essay is endogenously determined by the interplay of the administrative capacity of domestic regulators, the complexity or sophistication of the financial sector, and the existence of regulatory loopholes. The models suggest that capital controls, by internalizing externalities associated with capital inflows, can improve welfare relative to a “laissez-faire” benchmark even when these are imperfectly binding.
Long-term Trends in Intra-financial Lending in the U.S. (1950- 2012) (with G. Epstein and I. Levina) [link]
(Eastern Economics Journal)
This paper examines the evolution of intra-financial sector lending in the United States, 1950–2012, constructing estimates from the Federal Reserve’s Flow of Funds Accounts. Lending between financial institutions has grown nearly five-fold since the 1950s and currently accounts for roughly half of all financial sector lending. In the run up to the financial crisis of 2007–2008, the growth of intra-financial lending was concentrated in assets highly implicated in the genesis of the crisis, suggesting that this growth may have contributed to the crisis. This growth in intra-financial lending also raises questions about the contribution of the financial sector to the real economy.
Selected Other Papers
Overcharged: The High Cost of High Finance (with Gerald Epstein) [link]
Have Large Scale Asset Purchases Increased Bank Profits? (with Gerald Epstein) [link]
Capital Controls and Monetary Policy in Developing Countries (with José Antonio Cordero) [link]
Jamaica: Macroeconomic Policy, Debt, and the IMF (with Jake Johnston) [link]