Why do foreigners invest in the United States?

Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less-developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and there is no evidence that foreigners invest in the United States based on diversification motives. The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.

One Cost of the Chilean Capital Controls: Increased Financial Constraints for Smalles Traded Firms

There is growing support for taxes on short-term capital inflows in emerging markets, such as the encaje adopted by Chile from 1991-98. Previous empirical assessments of the encaje conclude that it may have generated some small economic benefits, such as shifting the composition of capital inflows to a longer maturity, but no significant economic costs. Managers of small and medium-sized companies in Chile, however, claim that the encaje made it substantially more difficult to obtain financing for productive investment. This paper assesses whether the Chilean capital controls increased financial constraints for different-sized, publicly-traded firms. It uses two different testing methodologies: a Tobin's q and Euler-equation framework. Results indicate that during the encaje, smaller traded firms in Chile experienced significant financial constraints and these constraints decreased as firm size increased. Both before and after the encaje, however, no group of traded firms experienced significant financial constraints, and there is no relationship between firm size and financial constraints. Although Chilean-style capital controls may also yield benefits encaje could be particularly important in emerging markets where smaller firms can be valuable sources of job creation and economic growth.

Capital Controls: Mud in the Wheels of Market Discipline

Widespread support for capital account liberalization in emerging markets has recently shifted to skepticism and even support for capital controls in certain circumstances. This sea-change in attitudes has been bolstered by the inconclusive macroeconomic evidence on the benefits of capital account liberalization. There are several compelling reasons why it is difficult to measure the aggregate impact of capital controls in very different countries. Instead, a new and more promising approach is more detailed microeconomic studies of how capital controls have generated specific distortions in individual countries. Several recent papers have used this approach and examined very different aspects of capital controls from their impact on crony capitalism in Malaysia and on financing constraints in Chile, to their impact on US multinational behavior and the efficiency of stock market pricing. Each of these diverse studies finds a consistent result: capital controls have significant economic costs and lead to a misallocation of resources. This new microeconomic evidence suggests that capital controls are not just sand', but rather mud in the wheels' of market discipline.

The Asian Flu and Russian Virus: Firm-level Evidence on How Crises are Transmitted Internationally

This paper uses firm-level information to evaluate how crises are transmitted internationally. It constructs a new data set of financial statistics, industry information, geographic data, and stock returns for over 10,000 companies in 46 countries to test what types of firms were most affected by the East Asian and Russian crises. Results suggest that a product-competitiveness and income effect were both important transmission mechanisms during the later part of the Asian crisis and the Russian crisis. For example, if a firm's main product line competed with a major East Asian export, the firm's average daily abnormal stock return was 13 percent lower during the Asian crisis. The magnitude of this product competitiveness effect during the Russian crisis was 32 percent. Results suggest that a credit crunch was not important during either crisis. Finally, country-specific effects, which are poorly explained by macroeconomic and corporate governance variables, can have a larger impact than all other transmission mechanisms combined.

Capital Controls: Mud in the Wheels of Market Discipline

Widespread support for capital account liberalization in emerging markets has recently shifted to skepticism and even support for capital controls in certain circumstances. This sea-change in attitudes has been bolstered by the inconclusive macroeconomic evidence on the benefits of capital account liberalization. There are several compelling reasons why it is difficult to measure the aggregate impact of capital controls in very different countries. Instead, a new and more promising approach is more detailed microeconomic studies of how capital controls have generated specific distortions in individual countries. Several recent papers have used this approach and examined very different aspects of capital controls - from their impact on crony capitalism in Malaysia and on financing constraints in Chile, to their impact on US multinational behavior and the efficiency of stock market pricing. Each of these diverse studies finds a consistent result: capital controls have significant economic costs and lead to a misallocation of resources. This new microeconomic evidence suggests that capital controls are not just "sand", but rather "mud in the wheels" of market disciplin

Why do Foreigners Invest in the United States?

Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and foreign investors “chase returns” in their purchases of U.S. equities (although not bonds). The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances

Trade Linkages and Output-Multiplier Effects: A Structural VAR Approach with a Focus on Asia

This paper develops a structural VAR model to measure how a shock to one country can affect the GDP of other countries. It uses trade linkages to estimate the multiplier effects of a shock as it is transmitted through other countries' output fluctuations. The paper introduces a new specification strategy that significantly reduces the number of unknowns and allows cross-country relationships to vary over time. Then it uses this model to examine the impact of shocks to 11 Asian countries, the U.S. and the rest of the OECD. The model produces reasonably good short-term forecasts. Impulse-response matrices suggest that these multiplier effects are large and significant and can transmit shocks in very different patterns than predicted from a bilateral-trade matrix. For example, due to these output-multiplier effects, a shock to one country can have a large impact on countries that are relatively minor bilateral trading partners.

The spillovers, interactions, and (un)intended consequences of monetary and regulatory policies

Have bank regulatory policies and unconventional monetary policies—and any possible interactions—been a factor behind the recent “deglobalisation” in cross-border bank lending? To test this hypothesis, we use bank-level data from the UK—a country at the heart of the global financial system. Our results suggest that increases in microprudential capital requirements tend to reduce international bank lending and some forms of unconventional monetary policy can amplify this effect. Specifically, the UK׳s Funding for Lending Scheme (FLS) significantly amplified the effects of increased capital requirements on cross-border lending. Quantitative easing did not appear to have a similar effect and countries with stronger prudential capital regulations were partially insulated against the effects of these changes in UK policy. We find that this interaction between microprudential regulations and the FLS can explain roughly 30% of the contraction in aggregate UK cross-border bank lending between mid-2012 and end-2013, corresponding to around 10% of the global contraction in cross-border lending. This suggests that unconventional monetary policy designed to support domestic lending can have the unintended consequence of reducing foreign lending. Keywords: Capital requirements; Funding for Lending Scheme; Financial deglobalisatio

Contagion in Latin America: Definitions, Measurement, and Policy Implications

This paper analyzes bond and stock markets in Latin America and uses these patterns to investigate whether contagion occurred in the 1990's. It defines shift-contagion' as a significant increase in cross-market linkages after a shock to one country or region. Several coin-toss examples and a simple model show that the standard tests for contagion are biased due to the presence of heteroscedasticity, endogeneity, and omitted-variable bias. Recent empirical work which addresses these problems finds little evidence of shift-contagion during a range of crisis periods. Instead, this work argues that many countries are highly interdependent' in all states of the world and the strong cross-country linkages which exist after a crisis are not significantly different than those during more stable periods. These findings have a number of implications for Latin America.