Capital Markets, Covid-19 and Policy Measures

Abstract

The COVID-19 episode triggered a historically large wave of capital reallocation and provided an opportunity to revisit the relevance of domestic policies for capital flows. Using high-frequency country-level data, this paper examines how COVID-19 cases, the stringency of the lockdown, and the fiscal and monetary policy response determined the dynamics of portfolio flows. Despite the sizeable impact of global factors, we find that domestic factors played a key role, particularly for emerging markets and bond flows. Our results indicate that higher domestic COVID-19 cases, tighter lockdown, and expansionary fiscal policy measures had a strong positive effect on portfolio flows. In contrast, we find that interest rate cuts led to a decline in portfolio flows, driven by developed markets. Finally, we show that these policies and pre-COVID-19 macroeconomic conditions contributed to countries' exposure to the global shock.

Keywords: Capital flows, COVID-19, Lockdown stringency, Fiscal policy, Monetary policy