International Capital Flows And Macroeconomic Stability

The relationship between capital flows and macroeconomic stability is a hot topic inthe study of international economics, and also an inevitable issue faced by us in the courseof opening capital account. Starting with a discussion on the feature of internationalcapital flows, this paper studies the effects of capital flows on macroeconomic stabilitybased on the existing literature. The main contents and innovative ideas in this paper are asfollows:1. After a discussion on the definition and the main characteristics of internationalcapital flows in the 1990s, this paper analyzes the magnitude and composition of capitalflows in our country based on the balance of payments. Then, this paper examines thedeterminants of capital flows based on the sample period 1982-2003. By means ofCointegration test, we get appropriate long-run relationship between capital flows and itsdeterminants. The short-term influences of those determinants are studied by the ErrorCorrection Model, which can describe the mechanism of adjustment toward long-termequilibrium. The results show that GDP growth is the most important factor in the longrun, but the rate difference is also an important determinant in the short run.2. Large capital inflows will be a shock to the macroeconomic stability, andinevitably resulting in the macroeconomic overheating. In a fixed exchange rate regime,this overheating is likely to be reflected in inflationary pressures. The empirical analysisbased on the total amount of foreign capital actually used shows that capital inflows arethe Granger causality of inflation by excessive expansion of money supply and aggregatedemand. In addition, heavy capital inflows cause a further deterioration of contradictorybetween domestic saving surplus and foreign capital inflows, and become one of thereasons leading to the use of capital inefficient, large capital flight and macroeconomicinstability.3. After reviewing the theory of currency crisis, which is the extreme form of themacroeconomic risks of international capital flows, we investigate the output effects ofcurrency crisis under the general framework of short-term equilibrium in the openingeconomy. Based on this, we further examine the impacts of the reversal of capital inflowson the cost of currency crisis. We find that the reversal of capital inflows further damagingthe real economy.4. In this paper, "contagion" – as opposed to "interdependence" – conveys the ideathat international propagation mechanisms are discontinuous. Based on this, our studyextendes on conventional measures of contagion defined as a marked increase ofcross-market correlation by directly investing the changes in the existence and directionsof causality to identify contagion. This method is applied to the studies on the causalitypattern between HongKong and domestic stock markets based on the returns and volatilitybefore and during the Asian crisis. The result shows that there is Granger causalitybetween the HengSheng index and B share index during the period of currency crisis, butnot the A share index.5. After review the policy measures of developing countries managed to overcomethe overheating of capital inflows, we evaluates our current policy stance and then providesome advices to improve the management of capital flows.