Unconventional Monetary Policy Normalization in High-Income Countries: Implications for Emerging Market Capital Flows and Crisis Risks

51 Pages Posted: 20 Apr 2016

See all articles by Andrew Burns

Andrew Burns

World Bank

Mizuho Kida

World Bank

Jamus Jerome Lim

World Bank

Sanket Mohapatra

Indian Institute of Management, Ahmedabad

Marc Stocker

European Central Bank (ECB)

Date Written: April 1, 2014

Abstract

As the recovery in high-income countries firms amid a gradual withdrawal of extraordinary monetary stimulus, developing countries can expect stronger demand for their exports as global trade regains momentum, but also rising interest rates and potentially weaker capital inflows. This paper assesses the implications of a normalization of policy and activity in high-income countries for financial flows and crisis risks in developing countries. In the most likely scenario, a relatively orderly process of normalization would imply a slowdown in capital inflows amounting to 0.6 percent of developing-country GDP between 2013 and 2016, driven in particular by weaker portfolio investments. However, the risk of more abrupt adjustments remains significant, especially if increased market volatility accompanies the unwinding of unprecedented central bank interventions. According to simulations, abrupt changes in market expectations, resulting in global bond yields increasing by 100 to 200 basis points within a couple of quarters, could lead to a sharp reduction in capital inflows to developing countries by between 50 and 80 percent for several months. Evidence from past banking crises suggests that countries having seen a substantial expansion of domestic credit over the past five years, deteriorating current account balances, high levels of foreign and short-term debt, and over-valued exchange rates could be more at risk in current circumstances. Countries with adequate policy buffers and investor confidence may be able to rely on market mechanisms and countercyclical macroeconomic and prudential policies to deal with a retrenchment of foreign capital. In other cases, where the scope for maneuver is more limited, countries may be forced to tighten fiscal and monetary policy to reduce financing needs and attract additional inflows.

Keywords: Debt Markets, Emerging Markets, Currencies and Exchange Rates, Banks & Banking Reform, Economic Theory & Research

Suggested Citation

Burns, Andrew and Kida, Mizuho and Lim, Jamus Jerome and Mohapatra, Sanket and Stocker, Marc, Unconventional Monetary Policy Normalization in High-Income Countries: Implications for Emerging Market Capital Flows and Crisis Risks (April 1, 2014). World Bank Policy Research Working Paper No. 6830. Available at SSRN: https://ssrn.com/abstract=2419786

Andrew Burns

World Bank

1818 H Street, N.W.
Washington, DC 20433
United States

HOME PAGE: http://econ.worldbank.org/staff/aburns

Mizuho Kida

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Jamus Jerome Lim

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Sanket Mohapatra

Indian Institute of Management, Ahmedabad ( email )

IIM Old Campus
Vastrapur
Ahmedabad, Gujarat 380015
India

Marc Stocker

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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