Capital Flow Dynamics and FX Intervention
14 Pages Posted: 6 Oct 2014
Date Written: October 2013
Many emerging markets have intervened in FX markets during and after the global financial crisis to dampen movements in exchange rates and smooth volatile capital flows. Firstly, we show that the joint dynamics of capital flows, FX changes and asset returns in emerging markets are largely consistent with portfolio rebalancing of international investors. This suggests that large and volatile capital flows are here to stay and policy makers will have to devise effective frameworks to deal with them. Secondly, we analyse the differences between FX interveners and non-interveners. We show that intervening economies, on average, have exhibited dynamics that are less destabilising. In particular since 2009, non-intervening economies tend to experience additional capital inflows in response to an exchange rate appreciation – and these capital inflows then create additional appreciation pressures on the exchange rate (ie a momentum effect). In contrast, intervening economies have been able to break the destabilising feedback loop of this momentum effect.
Keywords: FX intervention, portfolio rebalancing, capital flow dynamics
JEL Classification: F31, G11, G15
Suggested Citation: Suggested Citation