Selzaon of Capal Inflows and Balance of Paymens Cses Macos A. Buscagla Ths Daf: July 23 Absac Lage capal nflows and epeaed balance of paymens cses BOPC assocaed wh he sudden evesal have chaacezed he emegng make economes dung he 9's. Selzed nevenon has been he mos common esponse o capal nflows. Ths pape lnks he selzaon effos wh BOPC n a geneal equlbum model. We sudy an economy facng a empoay decease n he nenaonal nees ae, and show ha an aemp o selze capal nflows leads he economy o a BOPC, whle a pue Cuency Boad would avod. We ague ha hs expemen s elevan o undesand he 994 Mexcan cuency css. Key wods: Balance-of-paymens cses; Selzaon of capal nflows; Mexcan css JEL classfcaon: F3 ; F32 I would lke o hank Man Ube fo helpful commens and suggesons. I have also benefed fom commens fom Kaen Lews, Uban Jemann, Fenando Alvaez, Fancsco Cocchn, Nahan Poe, Felpe Zanna, and semna pacpans a he Unvesy of Pennsylvana, CEMA and Unvesdad de San Andés Agenna, he 2 LACEA meengs a Monevdeo Uuguay, and he Lunch Semna a he Fedeal Reseve Bank a Mnneapols. All eos eman mne. Unvesdad de San Andés. Vo Dumas 284, B644BID, Vcoa, Pov. Buenos Aes, Agenna. Ph.: 54-4725-78. E-mal: mbuscagla@udesa.edu.a
. Inoducon Two man economc evens have been domnan n he emegng make economes dung he 9's: he subsanal ncease n capal nflows compaed o he 8's, and he epeaed balance of paymens cses BOPC assocaed wh he sudden evesals of hese flows. Capal flows o Lan Ameca, whch aveaged less han $ 2 bllon a yea n he 8's appoxmaely $ bllon dung s second half, nceased o $ 7 bllon a yea dung he 9's IMF, 999. In developng Asa capal flows nceased fom an aveage of $4.9 bllon a yea n he 985-89 peod o $ 4 bllon a yea fom 99 o 994 Calvo e al., 994. The volaly of capal flows has also nceased. Sudden swngs n capal flows have been followed n mos cases by shap BOPC and deep economc conacons Calvo, 998. These evens have geneaed a subsanal debae among academcs and polcymakes. An eve-gowng sand of he leaue deals wh he causes of BOPC. A sepaae bu no oally unelaed sand of leaue deals wh he causes and consequences of he suge n capal flows o developng economes n he 9's. I has ceneed on whehe hs ncease has been a consequence of exenal o nenal facos, and on he opmal moneay/fscal/exchange ae polces o face. Calvo e al. 993 and 994 hghlghed he mpoance of exenal facos n he enewal of capal flows o Lan Ameca a he begnnng of he 9's. Capal flows nceased no only o counes undegong sucual efoms, bu also o some exen o counes ha dd no pefom subsanal changes o he unsound economc fundamenals. Whle he elave mpac of evens n developed economes on flows o emegng counes seems 2
o have dmnshed moe ecenly Monel and Renha, 997 and 999, hey connue o be hghly elevan o he deemnaon of he mng and magnude Monel and Renha, 997, and sudden capal flow evesals due o conagon fom ohe egonal emegng makes have become moe common. Developng counes seem o face peods of nceased confdence and capal nflows, whch n pa sem fom evens n he ndusalzed economes and/o n he nveso's assessmen of he egonal sk, and whose sudden evesal s uncean, egadless of he domesc economc polces pusued. Thee s also an exensve debae concenng he opmal moneay/fscal/exchange ae polces o face capal nflows. Capal nflows geneae an expanson n he domesc absopon of adable goods and nonadable goods and sevces, whch esul n a deeoaon of he cuen accoun and he eal exchange ae, especvely. These effecs ae wdely consdeed as sympoms of economc fagly by academcs and analyss, as hey have been ypcally pesen n counes ha suffeed ecen BOPC. Ths has led polcymakes o y o avod he appecaon of he eal exchange ae and he deeoaon of he cuen accoun. The mos wdespead ype of nevenon has been he selzaon of capal nflows. Sx ou of egh Lan-Amecan and Asan developng counes ncluded n Monel and Renha's 997 sudy mananed exended selzaon polces. By placng usually sho-em bonds n he domesc make, moneay auhoes nend o avod he expanson of domesc absopon and he ohe nal effecs of capal nflows. A leas hee objecons can be placed o he selzaon of capal nflows: 3
- By sellng bonds n he domesc make he cenal bank pevens he domesc nees ae o convege o he nenaonal one Renha and Renha, 998, nducng moe capal nflows and exacebang he nal poblem. 2- The low mauy of bonds ypcally used o selze nceases he vulneably of he economy Monel and Renha, 997. 3- Hghe domesc nees aes bng nceased fscal defcs. Ths s he fs pape o model n a geneal equlbum famewok he elaonshp beween he selzaon of capal nflows and balance of paymens cses. 2 We explo he fac ha he selzaon of capal nflows nceases he domesc nees ae and he fscal defc, and consde he case of an economy ha faces a empoay decease n he nenaonal nees ae. Ths paen, ognaed n economc evens n developed counes o n ohe counes n he egon, seems o be he one ha developng economes have faced n he 9's, as we agued above. We show ha an aemp o selze capal nflows leads he economy o a BOPC. The mechancs ae he followng. The selzaon of capal nflows nceases he domesc deb and he cenal bank's defc n he peod of low nenaonal nees aes. When nenaonal nees aes se, he selzaon of capal ouflows educes he elave eun of domesc bonds and nceases he ncenves fo a speculave aack n ha make, whch leads he economy o a BOPC. Is empcal elevance depends, n un, on he lengh of he selzaon effo and on he magnude of he nenaonal nees ae decease. The BOPC s avoded f he domesc nees ae s allowed o convege o he nenaonal one, as n a cuency boad. 4
Fnally, n ou model he BOPC akes place manly hough a speculave aack n he domesc bond make, a feaue obseved n some of he ecen epsodes. 3 Ths case seems paculaly elevan fo he undesandng of he 994 Mexcan cuency css. Some of he pevous papes ha fomalzed he Mexcan evens e.g., Kumhof, 998 assume ha he non-fnancal publc seco defc was he dve of he cuency css when, n fac, was vey low n he yeas pecedng he css. On he ohe hand, when nenaonal nees aes wee low dung 992 and 993 see Fgue, he Cenal Bank selzed capal nflows wh sho-em bonds, and lae dd he oppose selzaon of capal ouflows when he nenaonal nees ae saed o se n 994, monhs befoe he css see Fgue 2. [Fgue abou hee] [Fgue 2 abou hee] The es of he pape s oganzed as follows. In Secon 2 he heoecal model s descbed. In Secon 3 we show ha an aemp o selze capal nflows semmng fom a empoay decease n he nenaonal nees ae pus he economy on a pah leadng o a BOPC, an even ha would be avoded by a pue cuency boad. Secon 4 concludes. 2. The Model In hs secon we develop a smple pefec foesgh model of a small open economy n whch he demand of money and domesc bonds s movaed by a lqudy-n-advance consan. I can be consdeed as an nemedae sep beween he models of Calvo and Vegh 99, as we ncopoae a moe ealsc exogenous fscal consan, and Kumhof 998, as we exclude banks fom he analyss. 5
Thee s one adable good, whose supply s gven as a consan endowmen each peod o he epesenave agen. The epesenave agen has also access o an nees-beang nenaonal asse. 2. The Households The economy s populaed by an nfnely-lved epesenave household ha maxmzes he lfeme dscouned uly fom consumpon c U u c e s ρ s ds whee uc s C 2, scly concave, u c >, and u c as c. Assume ha he HH pefeences ae of he CEIS ype 4 c δ u c δ Households can nves n hee ypes of asses:. domesc money, m. domesc bonds ssued by he govenmen, d, whch pay a nomnal nees ae of each peod.. nenaonal asses, b, whch pay a consan nees ae of each peod s scly posve. 5 Assume fo smplcy ha ρ, o avod noducng unnecessay dynamcs n he model. The demand fo he fs wo asses s movaed by a lqudy-n-advance LIA consan L m, d αc 2 6
whee < α <. We assume ha L has a CES fom L σ σ σ σ A ωm σ ω σ d whee σ >, L m >, L d >, L md >, L mm <, L dd < and L s homogeneous of degee one. Le a be oal household's wealh a me. Then a m d b PPP holds and whou loss of genealy we can assume ha nenaonal nflaon s zeo so domesc nflaon equals he devaluaon ae.e., p& ε. Then oal wealh evolves accodng o a& y g c a d ε m ε 3 whee y s he consan endowmen pe peod and g ae he ne lump-sum ansfes eceved fom he govenmen. Ths s a dffeenal equaon n a. 6 Noe ha fo he LIA consan o be bndng, mus be he case ha he oppouny coss of money and domesc bonds ae scly posve:. ε >. The oppouny cos of money balances has o be scly posve. Ths s ue even when ε, as >.. ε >. Foegn bonds mus domnae local ones. Ths seems o conadc he fac ha emegng makes' local bonds ypcally pay a pemum ove nenaonal nees aes, and s a consequence of he way bonds ae noduced n he model. The nees ae dffeenal can be consdeed a lqudy pemum, as domesc bonds n hs economy povde necessay lqudy sevces. 7 Fom equaon 3 we can oban he pesen value budge consan 7
8 s s s s s s s s s ds e m d c ds e g y a ε ε 4 Equaon 4 expesses ha a evey pon n me he nal wealh plus he pesen value of all fuue eanngs LHS mus equal he pesen value of fuue consumpon plus he oppouny cos of holdng money and domesc bonds RHS. The household's poblem s o maxmze equaon subjec o equaons 2 and 4, gven he nal condons, by opmally choosng c and asse demands. The condons mposed mply he exsence of an neo soluon o hs poblem. We wll assume ha he LIA consan s bndng. Le λ be he mulple of consan 4 n he Hamlonan. The FOC wh espec o money holdngs and domesc bond holdngs ae especvely Lm c u ε α λ 5 and Ld c u ε α λ 6 whee Lm and Ld ae he paal devaves of L wh espec o money and bond holdngs especvely. Fom equaons 5 and 6 we can deduce ha Lm Ld ε ε 7 whch, along wh he funconal foms assumed fo he LIA consan, mples ha he elave demand of money and domesc bonds depends only on he elave euns σ σ ω ω ε ε d m 8
9 Defne I ε. Followng Kumhof 998, le σ ω ω W, I I X and σ X X Φ. Then we can expess X W d m Φ whee:,, > d m d m ε ε and, < d m ε gven ha,, > X X ε ε and, < X ε Usng he assumpon ha he LIA consan s bndng and he fac ha s homogeneous of degee one, we can deve demand equaons fo boh domesc asses, X W L c d Φ α 9 and,, X W L X c W m Φ Φ α In ode o faclae he exposon of he followng secons, s mpoan o undesand he effecs on money and bond demands of changes n he elave eun and he consumpon level. As d m depends only on W and X Φ, hen s easy o see ha,,,,, > c d c m ε ε We call hese changes level effecs. By Eule's Theoem, also follows ha
m X c > d and < X c so ha money balances acually ncease when nflaon o he nenaonal nees ae ncease and decease when he nees ae pad on domesc bonds nceases. The oppose s ue wh espec o domesc bonds. We call hese changes subsuon effecs. 8 Defne oal domesc lqud asses as l m d Then see Appendx fo a poof l c,, ε > l and < X c So when nflaon o he nenaonal nees ae go up lqud asses demand deceases, as he fall n he demand of domesc bonds exceeds he ncease n money demand. Ths s because n equlbum he magnal poducvy of govenmen deb s lowe han ha of money n povdng lqudy sevces see equaon 7 and so money, beng moe poducve a he magn, vaes less han govenmen deb. 2.2 The Govenmen We assume ha he govenmen fxes he nees ae on domesc bonds a, so ha. A each pon n me, he consoldaed publc seco budge consan s g d k & k ε m d d& m& 2 a pons of connuy and k m d
a jump pons, whee k ae he nenaonal eseves held by he cenal bank. Equaon 2 has he nepeaon ha a each peod ne govenmen lump-sum ansfes plus nees expenses and asse's changes LHS have o equal govenmen evenues plus lables change RHS. Moeove, a some pons n me hee can be dscee swaps of domesc money o bonds fo nenaonal eseves. We also assume ha he cenal bank fxes he exchange ae.e., ε, and ha hee s a lowe bound on he cenal bank's nenaonal eseves, below whch wll abandon he peg. Assume fo smplcy ha hs bound s zeo.e., k. Thoughou hs pape we assume ha he govenmen follows an exogenous fscal polcy, seng a pah fo g n advance. If an oveall defc esuls, has o be fnanced ehe by new deb, o by moneay expanson, o by he devaluaon ax ε m d >. If he demand of money and domesc bonds s consan n eal ems, and fε, hen any money-fnanced defc wll esul n eseve losses. We also assume he govenmen nally uns conssen moneay, fscal and exchange ae polces. Fom equaons 5, 9 and we can see ha fo ε, and fxed, consumpon and he demand of money and domesc bonds wll be consan mplyng ha. Fom equaon 2 we can see ha k & f and only f k g d 3 so he govenmen needs a pmay suplus g < suffcen o cove ne nees paymens n ode o acheve global fscal balance. 9
2.3 The Aggegae Economy Toal ne foegn bond holdngs n he economy, f, ae he addon of HH's holdngs and Cenal Bank's eseves f b k 4 So f & b& k&, and he evoluon of oal foegn bond holdngs n he economy s equal o f & f y c 5 whch means ha he accumulaon of ne foegn asses s equal o he cuen accoun balance. Inegang fowad and mposng he ansvesaly condon lm f e, we ge he economy's lfeme esouce consan f y c e s s ds 6 mplyng ha he pesen value of consumpon RHS has o be equal o he pesen value of esouces LHS. Noe ha fom equaon we can also calculae he consan level of consumpon ha keeps he ne foegn asses holdngs unchanged fom ha peod on c f y 7 2
2.4 Level Effecs Changes n, ε, o bng level effecs only f hey esul n changes n he cuen consumpon level. Cuen consumpon levels can change ehe because of wealh effecs o because of neempoal subsuon effecs IS. The em beween backes a he RHS of equaon s he effecve pce of consumpon, q, whch nceases when I nceases.e.: when o ε ncease, and deceases when nceases. To be moe explc, we follow Calvo and Vegh 99 and assume fo now ha δ.e.: ha he uly funcon s logahmc. Then we can expess consumpon as c f e d α ε Ld y α ε Ld 8 whee Calvo and Vegh call he las em on he RHS he Magnal Popensy o Consume MPC ou of pemanen ncome. We can hnk of as he ao of he aveage effecve pce of consumpon o he cuen one. Unancpaed flucuaons n empoay o pemanen bng wealh effecs, as hey modfy he lfeme esouce consan of he economy equaon. Fo he same eason, changes n o ε empoay o pemanen do no bng wealh effecs. A empoay change n o ε bngs an neempoal subsuon effec, as modfes he effecve pce of consumpon unevenly acoss me.e., change he MPC n 3
equaon 8. Wh an exogenous fscal consan, pemanen changes n mgh be able o bng an neempoal subsuon effec, a esul ha dffes fom Calvo and Vegh 99. Fnally, les specfy a esul ha wll be used lae. Poposon. An ncease decease n and n he same popoon nceases deceases he effecve pce of consumpon. Poof. Sang fom q defned as n he RHS of equaon, noe ha q I q I > α Ld Ld I α α > I α Ld I Ld I Ld I Ld > I I > < I whch was assumed n ode o have he LIA consan holdng n equaly 3. Changes n Inenaonal Inees Raes and BOPC 4
In hs secon we consde he case of a small open economy ha faces an unexpeced empoay decease n he nenaonal nees ae a. We assume ha po o ha dae he economy was n seady sae. The pah of nenaonal nees aes s gven by l T h < and T whee h and l h l > denoe he hgh and low nenaonal nees aes, especvely see Fgue 3 [Fgue 3 abou hee] We have aleady emphaszed ha such a paen of capal nflows and sudden ouflows followng economc changes n developed counes seems o be he mos elevan fo emegng economes. In pacula, hs expemen seems o be elevan fo he analyss of he 994 Mexcan cuency css, as we agued n Secon. The empoay decease n he nenaonal nees ae s expeced o esul n a suge of capal nflows, as he elave eun of domesc asses nceases. The cenal bank n ou model can ehe educe he domesc nees ae o keep consan. We call selzaon o he case n whch keeps consan, n analogy wh he obsevaon ha he domesc nees ae nceases o does no fall when cenal banks y o place he bonds wh whch hey selze capal nflows. Fgue 4 shows he me-pah of he nees ae on he domesc bond n he selzaon case. We show ha f he govenmen es o selze capal nflows, ses he economy n a pah leadng o a BOPC. [Fgue 4 abou hee] 5
If, on he conay, he govenmen les he domesc nees decease along wh he nenaonal one, no BOPC would ake place. We call hs case a cuency boad aangemen fo wo easons. Fs, he empcal leaue shows ha domesc nees aes conveged fase o he nenaonal one n counes wh cuency boad aangemens a he begnnng of he 9 s. Second, absen sk, he elave euns of domesc and nenaonal bonds should say he same f he govenmen does no engage n an nees ae polcy. 2 Fgues 5 shows he me-pah of he domesc bond nees ae n he case of he pue cuency boad. [Fgue 5 abou hee] I would be moe ealsc o assume ha he mng of he nenaonal nees ae evesal s uncean. We deve ou esuls assumng full ceany abou T and leave he uncean case fo fuhe eseach. 3. Pue Cuency Boad Case In he pue cuency boad case, we can deve a geneal esul. 3 Poposon 2. In he Cuency Boad case, an unexpeced empoay decease n he nenaonal nees ae does no se he economy n a pah leadng o a BOPC. Poof. We wan o show ha nenaonal eseves do no fall dung he low nenaonal nees ae peod, and so hee wll no be a cuency css afewads. Defne x as he pecenage decease n he nenaonal nees ae.e., -x. In hs case he nees ae pad on domesc bonds expeences he same change as he 6
nenaonal nees ae. Ths mples ha he RHS of equaon 8 emans unchanged, as x x x meanng ha hee ae no subsuon effecs a. Assume fo now ha hee ae no level effecs a also. Then budge balance eques g fo < d k g & k fo x d k x & k x k d Gven he condons assumed k d g <, k&. Ths means ha he cenal > bank nceases s nenaonal eseves dung he peod of low nenaonal nees aes. Now we wan o ague ha hee s a posve level effec a. We have shown n Secon 2 ha a popoonal decease n and nduces a decease n he effecve pce of consumpon. Le q l and q h be he effecve pce of consumpon when he nenaonal nees ae s low and hgh, especvely. Fom o T he dscoun ae wll be hghe han he nenaonal nees ae and so consumpon wll no be consan houghou ha peod. In pacula, as he epesenave agen s elavely mpaen, he wll have a deceasng consumpon paen. I can be shown ha consumpon n hs case s gven by c l δ δ Γ Ξ q e 9 Fo T, whee Γ f e y T e T 7
and Ξ q l δ δ δ e δ δ q e T δ δ T h δ Afe T, consumpon s equal o δ l q c ct 2 h q whee C T s gven by equaon 9 evaluaed a T. Fom equaons 9 and 2 we can deduce ha: - The MPC nceases a, as he denomnao deceases moe han he numeao IS effec. In addon, as f s assumed o be negave, a fall n he nenaonal nees ae nceases he wealh of he epesenave agen wealh effec. So a me hee wll be an ncease n consumpon. - Consumpon falls fom o T. Ths can easly be seen by evaluang equaon 9 a hose pons. - Consumpon falls a T, as q l <q h - Consumpon s consan afe T Fom he fs of hese pons we see ha hee s a posve level effec a. The posve level effec nceases m, d, and hence o a geae exen k. Ths enhances he ae of gowh of eseves, alhough hs effec s paally offse by he fall n consumpon up o T. 8
3.2 Selzaon We model he selzaon case as ha n whch he Cenal Bank does no allow he domesc nees ae o be educed along wh he nenaonal one, asng he elave eun of he domesc bonds and hus he demand. Ths acon deeoaes he poson of he domesc publc seco, whch now eceves less nees evenues fom s nenaonal eseves and pays moe fo s domesc publc deb because quanes ncease. 4 The mpac of hese changes on he fnances of he publc seco depends on he lengh of he nenaonal nees ae decease, and he magnude of he nenaonal nees ae decease. Fo a vey small decease and/o a vey sho peod of low nees aes, he selzaon effecs can be nsgnfcan fom a paccal pon of vew. If he deeoaon of he publc seco fnances bngs a BOPC hee ae hee possble cases, dependng on whehe akes place befoe, dung, o afe he me a whch he nenaonal nees ae ses agan T. We ea hee only he las case. Fgue 6 shows one possble pah fo nenaonal eseves. [Fgue 6 abou hee] Noe ha we can dsngush fou peods: 5 - Peod The govenmen uns conssen moneay, fscal, and exchange ae polces. The nenaonal nees ae s 2- Peod < T h. The nenaonal nees ae deceases o l, bu he domesc nees ae s kep consan.e., > l 9
3- Peod 2 T < T ' The nenaonal nees ae s back a 4- Peod 3 T ' h. A T hee s a cuency css and he govenmen abandons he peg. In he selzaon case we can deve he followng esul: Resul: If he govenmen es o selze capal nflows when hee s a empoay decease n nenaonal nees aes, ses he economy n a pah leadng o a BOPC. We have o show ha hs polcy leads he economy o a collapse of he exchange ae a T. Ths s done nex n wo seps. Fs we show ha f hs polcy esuls n a loss of eseves ha makes hem h he lowe bound, hen he devaluaon ae ε 3 wll be scly posve afe T. Then we show ha hs polcy s n fac unsusanable.e., leads o a loss of eseves. 6 Fs we have o show ha f k afe T, ε > 3. Budge balance afe T eques n hs case ha: Ψ ε m d g d 2 3 3 3 3 Noe ha dvdng boh sdes by d 3 we ge, fo and consan, a funcon of ε and c. As fo posveness, noe ha by assumpon, whle as g > Ψ, c g d 3 < Ψ ε c m d g d 3, 3 3 3 g m3 > 2
To pove monooncy, dvde boh sdes of equaon 2 by d 3, o ge m ε g d3 3 3 d3 Defne: m 3 Θ and d 3 Θ Υ. We know ha: > d 3 ε, Υ and > ε, see equaon 8. Then g < mples ha a unque posve ε 3 sasfes condon 2. Then we have o show ha hs polcy leads o a depleon of eseves. The nuon s he followng. The fall n nenaonal nees aes bngs a subsuon effec and a level effec a. If hee s a BOPC a some pon n he fuue, hee would be an addonal level effec a. The addonal level effec would unambguously ncease he sock of domesc bonds a. If made he suaon susanable, hen ε 3 and hee would be no BOPC. Bu hs s a conadcon, snce he addonal level effec s condonal on he BOPC akng place. So we only need o show ha he nal subsuon and level effecs leave he publc seco unbalanced. Budge balance eques g fo < d k g d d k& x k fo k g d d k& k k x k k & k k x xk d So k & < fom o T ff k x xk d < 2
22 k k d k x > 22 To calculae he values of k, d, and he level of eseves a T, we need he value of consumpon houghou hs peod. Fom o T he dscoun ae s hghe han he nenaonal nees ae, and so he epesenave household wll have a deceasng consumpon pah. We can calculae ha [ ] T T T T T d e c Fe g e k k k 23 whee c s gven by equaon 9, and σ σ σ σ ω ω α A F Noe ha we can smplfy calculaons by fndng he consan consumpon pah ha s equvalen n pesen value o he led one dung he anson peod. We wan o fnd a consan c such ha T T d e c d e c I can be shown ha c s gven by δ Γ Ξ Λ l q c 24 whee Γ and Θ ae as befoe, and Λ T T e e δ δ δ δ Afe T, publc seco balance eques T T T T k k k d d g &
So k & < fo >T ff k k g d d 25 T T T T < whee k T s gven by equaon 23. We canno deve analycally explc hesholds combnaons of T and x n hs case above whch he economy wll have a BOPC a some fne pon n he fuue. Tha s, we canno check analycally whehe condons 22 and 25 ae smulaneously sasfed and so eseves fall no only fom o T, bu also afe T. Numecal smulaons show ha any combnaon of x and T would lead he economy o a BOPC f he govenmen es o selze deals avalable upon eques. Wha vaes s he empcal elevance of hese changes, as a small x and T would dsup publc fnances by lle and he BOPC would only be a dsan even. To gan fuhe nsgh we ask he followng queson: wha adjusmen o he pmay suplus would be needed a T o esoe fscal balance whou losng eseves fom hen on avodng a fuue BOPC. In Fgue 7 we pesen he esuls of numecal smulaons fo dffeen combnaons of x and T n he case n whch he dscoun case moves along wh he nenaonal nees ae no pesened above, and n Fgue 8 n he consan dscoun ae case. Values n he y-axs epesen he fscal adjusmen as pecen of GDP needed o esoe fscal balance a T. If hee s, fo example, a decease n he nenaonal nees ae of 3 pecen ha lass fo T9 peods, hen a T he govenmen has o ncease he pmay suplus n.3 pecen of GDP o esoe fscal balance. Ohewse, a BOPC wll ake place n he fuue. As expeced, longe peods of selzaon.e., of low nenaonal nees aes and shape educons n he nenaonal nees ae.e., lage 23
nceases n he elave eun of domesc bonds lead o hghe equed fscal adjusmens a me T. [Fgue 7 abou hee] I may seem ha long yeas of low nenaonal nees aes ae equed o geneae a szable fscal dsequlbum when he cenal bank selzes capal nflows. Bu ha s no he case n he conex of he model, as fo easonable paamee values would ake many peods o poduce a fs geneaon BOPC esuls ae avalable upon eques. In he examples jus suded he selzaon of capal nflows unbalances he fnances of he publc seco. Monezaon of he defc leads o a loss of nenaonal eseves and ulmaely o a BOPC, as shown n Fgue 6. Bu hs soy conadcs he fac ha counes ha selze usually ncease he nenaonal eseves dung peods of low nenaonal nees aes see Fgue 2 fo an example. Ths counefacual esul could be ovecome f nsead of assumng ha he defc s monezed we assume ha s fnanced wh deb, and ha hee s an uppe bound on he level of deb oleaed. We leave ha execse fo fuhe eseach. 7 3.3. Dscusson We have agued n hs secon ha an aemp by he cenal bank o selze he capal nflows ha would follow fom a empoay educon n he nenaonal nees ae ses he economy n a pah leadng o a BOPC. I s mpoan o noce ha n ou model he govenmen selzes wce. I fs selzes capal nflows by no leng he domesc nees ae o decease along wh he 24
nenaonal one. Bu also selzes capal ouflows afe he nenaonal nees ae nceases agan, by keepng he domesc nees ae consan. 8 The mechancs ae he followng. The selzaon of capal nflows nceases he domesc deb n he peod of low nenaonal nees aes, and he fscal defc ceaed n hs way educes nenaonal eseves. When nenaonal nees aes se, he selzaon of capal ouflows educes he elave eun of domesc bonds and nceases he ncenves fo a speculave aack n ha make, whch leads he economy o a BOPC. I has been agued ha hs expemen s based, n he sense ha only consdes he case of a empoay decease n he nenaonal nees ae fo an economy ha was a seady sae a he hgh nenaonal nees ae level. Bu hs seems o be he elevan seup o analyze he 994 Mexcan BOPC. The economy seemed no o be headng o a BOPC befoe 992, and he Cenal Bank selzed capal nflows fom 992 o Febuay of 994, when saed o selze capal ouflows. The eason why we call 992-93 a peod of empoay low nenaonal nees aes s clea fom Fgue. 4. Conclusons and Fuhe Reseach Two man economc evens have been domnan n he emegng make economes dung he 9's: he subsanal ncease n capal nflows compaed o he 8's, and he epeaed balance of paymens cses BOPC assocaed wh he sudden evesals of hese flows. Empcal fndngs pon ou ha exenal facos connue o be hghly elevan o he deemnaon of he ``mng and magnude'' of capal flows o developng counes. 25
Polcymakes have usually ed o avod he expansonay effecs of capal nflows, and selzaon has been he mos wdespead ype of nevenon. Ths s he fs pape o model n a geneal equlbum famewok he elaonshp beween he selzaon of capal nflows and balance of paymens cses. Many objecons can be placed on selzaon, amongs hem ha deeoaes he fnances of he publc seco. We have exploed hs fac o ague ha, unde dffeen assumpons concenng he conssency of he moneay/fscal polcy wh he exchange ae peg, selzaon s neve he bes polcy esponse o capal nflows. Ths s because he selzaon ehe ancpaes he BOPC o pus he economy n a pah leadng o a BOPC whle he cuency boad would no, dependng on he assumpons. We have also shown ha n he conex of pefec foesgh and pefec capal mobly selzaon s neffecve n he sense ha does no educe he cuen accoun defc. Ou esuls sugges ha an aemp o selze he capal nflows ha would follow fom a empoay educon n he nenaonal nees ae ses he economy n a pah leadng o a BOPC. We have analyzed he empcal elevance of hs poblem, whch depends on he me-exenson and he magnude of he nees ae decease. Ths case seems paculaly elevan fo he undesandng of he 994 Mexcan cuency css. Some of he pevous papes ha fomalzed he Mexcan evens assume ha he non-fnancal publc seco defc was he dve of he cuency css when, n fac, was vey low n he yeas pecedng he css. On he ohe hand, when nenaonal nees aes wee low dung 992 and 993, he Cenal Bank selzed capal nflows wh sho-em bonds, and lae selzed capal ouflows when he nenaonal nees ae saed o se n 994, monhs befoe he css. 26
Fuhe eseach may exend he analyss n a leas wo decons. One s o lf up he assumpon ha defcs ae monezed dung he low nenaonal nees aes peod. As agued above, hs leads he model o have some conefacual esuls. The second s o noduce unceany n he mng of he nenaonal nees ae hke. As Dazen and Helpman 987 show n a dffeen conex, hs may gve addonal neesng dynamcs o he model. Appendx We wan o show ha l X c < l X c αc L Φ X WL Φ X L W Φ X Φ X 2 C α L Φ X W { L L L Φ X } 2 m m The em n backes s negave fom Eule's Theoem and he fac ha L m >L d n equlbum. 27
Refeences Ades, A., Buscagla, M., Mash, R., 2. Wha Heas Ho Money? Mmeo. Calvo, G., 986. Tempoay Sablzaon: Pedeemned Exchange Raes. The Jounal of Polcal Economy, Volume 94, Issue 6. Calvo, G., 987. Balance of Paymens Cses n a Cash-n-Advance Economy. Jounal of Money, Ced and Bankng, Vol.9, No.. Calvo, G., 987b. On he Coss of Tempoay Polcy. Jounal of Developmen Economcs 27. Calvo, G., 995. Capal Flows and Macoeconomc Managemen: Tequla Lessons. Mmeo. Calvo, G., 996. The Pels of Selzaon, n: Calvo, G., Money, Exchange Raes, and Oupu. MIT Pess, Cambdge, Mass. Calvo, G., 998. Capal Flows and Capal-Make Cses: The Smple Economcs of Sudden Sops. Jounal of Appled Economcs, Vol., No.. Calvo, G., Mendoza, E, 995. Mexco's balance of paymens css: a choncle of a deah foeold. Jounal of Inenaonal Economcs 4, 235-264 Calvo, G., Vegh, C., 99. Inees Rae Polcy n a Small Open Economy. The Pedeemned Exchange Raes Case. IMF Saff Papes, Vol. 37, No. 4. Calvo, G., Ledeman, L., Renha, C., 993. Capal Inflows and Real Exchange Rae Appecaon n Lan Ameca. The Role of Exenal Facos. IMF Saff Papes, Vol. 4. Calvo, G., Ledeman, L., Renha, C., 994. Inflows of Capal o Developng Counes n he 99s: Causes and Effecs. Wokng Pape 3, Offce of he Chef Economcs. Ine-Amecan Developmen Bank. Cumby, R., Obsfeld, M., 983. Capal Mobly and he Scope fo Selzaon: Mexco n he 7's, n: Aspe, P., Donbusch, R., Obsfeld, M. eds., Fnancal Polces and he Wold Capal Make: he Poblem of Lan Amecan Counes. Dhymes, P., 974. Economecs, Sascal Foundaons and Applcaons, New Yok, Spnge-Velag. Dazen, A., Helpman, E., 987.. Sablzaon wh Exchange Rae Managemen. Jounal of Economcs Novembe. Dazen, A., Helpman, E., 99. Inflaonay Consequences of Ancpaed Macoeconomc Polces. Revew of Economc Sudes 57, 47-66. Echengeen, B., Rose, B., Wyplosz, C., 996. Conagous Cuency Cses. NBER Wokng Pape 568. IMF, Wold Economc Oulook vaous ssues. Kamnsky, G. 997. Cuency and Bankng Cses: The Ealy Wanngs of Dsess. Mmeo. Kumhof, M., 998. Balance of Paymens Cses: The Role of he Sho Tem Deb. Wokng Pape. Kumhof, M., 999. Capal Inflow Selzaon-Though Lowe Inees Raes? Wokng Pape Lah, A., Vegh, C., 999. Delayng he Inevable: Opmal Inees Rae Polcy and BOP Cses. Mmeo. Lucas, R. J., 987. Models of Busness Cycles. Basl Blackwell. 28
Mendoza, E. and Ube, M., 999. Devaluaon Rsk and he Syndome of Exchange Rae Based Sablzaons. NBER Wokng Pape 74. Monel, P., Renha, C., 997. Do Capal Conols and Macoeconomc Polces Influence he Volume and Composon of Capal Flows? Evdence fom he 9s. Mmeo. Monel, P., Renha, C., 999. The Dynamcs of Capal Movemens o Emegng Economes Dung he 99s, n: Gfh-Jones, M. eds., Sho-em Capal Movemens and Balance of Paymen Cses. Oxfod Unvesy Pess, fohcomng 999. Mundell, R., 968. Inenaonal Economcs. New Yok: Macmllan. Ogak, M., Osy, J., and Renha, C., 996. Savng Behavo n Low- and Mddle- Income Developng Counes. IMF Saff Papes, Vol. 43. Mo., Mach. Renha, C., Renha V., 998. Some Lessons fo Polcy Makes Dealng wh he Mxed Blessng of Capal Inflows, n: M. Kahle ed., Capal Flows and Fnancal Cses. Councl on Foegn Relaons New Yok. Sack, B., 998. Unceany, Leanng, and Gadual Moneay Polcy. Wokng Pape, Boad of Govenos of he Fedeal Reseve Sysem. Ube, M., 997. On he Analcs of Cedble Exchange-Rae-Based Dsnflaon when Money Faclaes Fms's Tansacons. Fedeal Reseve Boad. Ube, M., 997b. Exchange-ae-based nflaon sablzaon: he nal eal effecs of cedble plans. Jounal of Moneay Economcs 39. We have updaed Calvo e al. s 993 mehodology and analyzed he deemnans of capal flows o nne emegng makes fom 99 o 998, usng quaely capal flows daa fom he IFS. The counes ncluded ae Agenna, Bazl, Chle, Mexco, Peu, Indonesa, Koea, Phlppnes and Thaland. Ou esuls ndcae ha hee s a hgh degee of comovemen n capal nflows among counes n he same egon, and ha hey ae hghly coelaed wh a vaable ha eflecs he lqudy condons n developed counes. The esuls ae avalable fom he auho upon eques. Ades e al. 2 fnd smla esuls fo pofolo flows. 2 Calvo 996 pesens a polcal-economy model showng ha he selzaon of capal nflows leads o hghe nflaon and dsoonay axes han unde no selzaon. 4 In he sandad Kugman-ype model, a he me of he speculave aack hee s a dscee fall n he moneay base. In some ecen epsodes, howeve, he speculave un has been ceneed n he domesc bonds' make, whle he moneay base emaned consan. Kumhof 998 models hs as he esul of he effos of he Cenal Bank o selze capal ouflows a he me of he aack. We adop Kumhof's funconal foms. All he vaables n he model ae defned n domesc cuency eal ems, excep fo. 2 In wha follows, we call γ pmay balance. Noe ha γ< denoes a pmay suplus. 3 Ths mples ha Uncoveed Inees Pay does no hold. If we could boow n domesc cuency a ae ι and nves n a foegn bond, we could ge a pe-peod excess eun of ε -ι. Bu noe ha we canno boow a ae ι, snce lendng a ha ae s domnaed by lendng a he pue and cean nees ae ε. 4 Behnd hs appaenly coune-nuve esul les he fac ha when he devaluaon ae o he nenaonal nees ae ncease, he oppouny cos of domesc bonds nceases popoonaely moe han he oppouny cos of money balances. And, fo a gven level of consumpon, he oal lqudy sevces o povde emans he same. 5 We assume ha nally d > k. 29
8 Noe ha hee s no sk n ou model, bu he changes n could be well nepeed as changes n he sk assocaed wh he egon due o, fo example, conagon. Noe also ha he descbed pah s a smplfcaon, as n ealy hee s subsanal evdence of nees ae smoohng. See Sack 998. 6 In ealy, domesc nees aes n emegng makes ae much hghe han he US nees ae. The model, on he conay, pesens he anomaly of havng he domesc nees ae lowe han he nenaonal one. In ealy, when he lae deceases, domesc aes decease much fase n counes wh cuency boad aangemens. By analogy, we assume he same n he model. Moe on hs below. 7 The analogy has s caveas. In a pue cuency boad he cenal bank only exchanges domesc money fo nenaonal eseves, whle n he model he cenal bank sll acceps bond exchanges f s asked o. We hank Man Ube fo makng us o noe hs. We show ha as hee s no subsuon effec n a pue cuency boad, bond exchanges ase only as a consequence of level effecs, and hey ae no sgnfcan. 9 Kumhof 999 poposes he educon of domesc nees aes as an effecve way o selze capal nflows. Hee we go one sep beyond, agung ha falng o lowe he domesc nees ae could no only senghen capal nflows, bu also pu he economy n a pah leadng o a BOPC. 2 Ths s paally offse because he se n he demand of domesc bonds a nceases nenaonal eseves. Bu, fo he same eason, money demand falls. Alhough he oal subsuon effec on lqud asses demand s posve see Appendx, he ncease n nenaonal eseves s lowe han he one n domesc bonds ousandng. 5 We use subscps,, 2 and 3 fo he vaables n he coespondng peods. 6 Hee we do no calculae he mng of he speculave aack, as s usual n BOPC models see Calvo, 987, and Kumhof, 998. 22 See Dazen and Helpman 99 fo a smla execse n anohe conex. 23 The selzaon of capal ouflows s behnd he esuls deved by Kumhof 998. Lah and Vegh 999, on he conay, sudy he effecs of fghng capal ouflows wh nceased domesc nees aes. 3
Fgue. US Sho-Tem Inees Rae 2 5 Pecen p.a. 5 Real Nomnal -5 ene-7 ene-73 ene-75 ene-77 ene-79 ene-8 ene-83 ene-85 ene-87 ene-89 ene-9 ene-93 ene-95 ene-97 - Fgue 2. Mexco: Moneay Base and Inenaonal Reseves 4 2-2 Dec-9 Ma-9 Jun-9 Sep-9 Dec-9 Ma-92 Jun-92 Sep-92 Dec-92 Ma-93 Jun-93 Sep-93 Dec-93 Mon. Base In. Reseves Ne D. Ced
Fgue 3. Inenaonal Inees Raes 2 T Fgue 4. Selzaon case Inenaonal Inees Rae Domesc Inees Rae T 2
Fgue 5. Cuency boad case Inenaonal Inees Rae Domesc Inees Rae T Fgue 6. Evoluon of Inenaonal Reseves nees ae decease nees ae ncease BOPC T T''' 3
Fgue 7. Fscal adjusmen a T as % of GDP needed o esoe balance,35,3,25,2,5,,5, x3% x2% x% 2 3 4 5 6 7 8 9 Value of T 4