Cross-border Capital Flows And The Choice Of Exchange Rate Regimes

In the context of limited global financial integration,the international financial system is accompanied by the development of international trade.At this time,the essence of floating exchange rate regime absorbing external shocks is to rebalance the current account to adjust the global imbalances.However,with the development of the world economy from global economic integration to global economic and financial integration,the growth rate and scale of cross-border gross capital flows have risen rapidly,and they have exhibited a global financial cycle phenomenon.From the global imbalances to the global financial cycle,the role of the international financial system also shift from allocating physical resources efficiently to deriving liquidity and nominal purchasing power.So,under the trend of free capital flow,can net capital flows reflect the accumulation of financial risks? Is the choice of exchange rate regime based on “trilemma” or “dilemma”? Can the floating exchange rate regime be a buffer for external shocks? What kind of factors can influence the buffering effect?This paper takes cross-border capital flows as the main line and the multinational banks as the starting point,to analyze the mechanism of floating exchange rate regime about how to absorb external shocks in depth.Specially,in this paper we mainly discuss the following issues: First,under the background of the Fed’s rate hikes and the global risk appetite shocks,what is the buffering mechanism of the floating exchange rate regime for net capital flows and gross capital flows? And what are the differences and connections? Second,under the background of global financial cycle,the global crossborder gross capital flow mode is how to form through multinational banks? And under this mode,what kind of exchange rate regimes can mitigate the external shocks to cross-border capital flows in emerging and developing countries? Third,when we focus on a couple of counterparties in the cross-border financial transactions,how the heterogeneous characteristics of counterparty countries affect the function of the exchange rate regime as a buffer of the bilateral capital flows of multinational banks? Forth,from the global imbalances to the global financial cycle,what is the nature of exchange rate and what has changed in the mechanism of exchange rate regimes? In this paper,we attempts to put forward policy recommendations for China’s exchange rate regime reform by answering the above questions.First,this paper begins with the historical evolution of global exchange rate regimes and the stylized facts of cross-border capital flows to analyze.The study found that the world economy has gradually evolved from a global economic integration to a global economic and financial integration.And under this background,the new features of cross-border capital flows and the multinational banks’ capital flows showed that the financial factors play a more important role in international analysis.Policy makers should not limited to the trade-off between “monetary trilemma” when they choose the exchange rate regime,but also need to measure between “financial trilemma”.That is to say,the new characteristics of cross-border capital flows have challenged the classical theory of exchange rate regime selection.Secondly,based on the overall perspective of the balance of payments data,this paper examines the buffer effect of the floating exchange rate regime on capital flows from the perspective of external yield shocks and external risk shocks.It is found that the floating exchange rate regime can absorb the impact of external yield shocks on net capital flows and the impact of external risk shocks on gross capital flows.While for short-term international capital flows,the floating exchange rate regime can act as a buffer to absorb the both shocks.In addition,the gross capital flows of all countries are more sensitive to external risk shocks,although the floating exchange rate regime can play a certain degree of buffering,the buffer effect is relatively small to offset the navigate impacts,so it presents the “dilemma” illusion.Thirdly,based on the preliminary examination of the external shock buffer of floating exchange rate regime,this paper starts from the multinational bank’ capital flows of global bank system to analyze the formation of cross-border gross capital flows mode.It is found that the cyclical flows between developed countries’ multinational banks not only affects the global liquidity and credit conditions,but also accumulates financial risks and transmits them into emerging and developing countries.Subsequently,this paper further test the buffering mechanism of floating exchange rate regime based on the BIS data of cross-border banks in emerging and developing countries.The study found that although the floating exchange rate regime can absorb the external risk impact on the multinational banks’ capital flows,the results are not significant,while the buffering effect on non-banking sectors is significant.That is to say,a large number of capital controls and less development of financial market in emerging and developing countries hinder the buffering effect of more flexible exchange rate regimes.Fourth,in this paper we also use the gravity model to further examine the buffering effect of floating exchange rate regime on the bilateral capital flows.It is found that the stronger “gravitational relationship” between the pairs is,namely the smaller geographical distance and common language and geographical boundaries,the lower information asymmetry and the lower transaction costs of multinational banks.When external shocks is coming,multinational banks located in those countries which adopt more flexible exchange rate regimes can timely adjust the exchange rate to hedge external risks,thereby increasing the bilateral assets holding positions of multinational banks.Finally,this paper begins with the essence of exchange rate to discuss the mechanism of exchange rate regimes in global imbalances and global financial cycle.We found that the commodity price attribute of the exchange rate enables floating exchange rate regime to adjust external economic imbalances through trade adjustment channels,while the asset price attribute of exchange rate enables the floating exchange rate regime to influence internal financial stability through financial adjustment channels.Subsequently,in light of the new characteristics and new trends in China’ capital flows,this paper suggests that RMB exchange rate flexibility should be enhance appropriately,macro-prudential supervision and coordination of international financial policies should be strengthened,and domestic financial market reforms should be continuously promoted.All of these are to provide a good institutional background and financial market environment for floating exchange rate regime to function buffering role.