The Effects Of International Capital Flows On Credit Volatility In Emerging Economies

Under the background of recent credit boom-bust cycle in emerging economies, the problem of credit volatility is becoming more and more conspicuous. The crisis of the developed economies in 2008-09 has focused new attention on money and credit fluctuations, financial crises, and policy responses. During the pre-crisis period, emerging and developed economies experienced substantial cross-country variation in domestic credit growth and international capital flows. High capital inflows were related to better growth performance but may also have created greater credit volatility via different channel. This paper investigates the inter-relations between domestic credit volatility and international capital flows.In this paper, we first use the theory of money supply, balance-sheet channel and debt-deflation theory to explain the inter-relations. Then we construct Risk-taking Channel Model, which can explain the relationship between domestic credit volatility and international capital flows from the theoretical point of view, further enriching the mechanism.In the empirical part, we select a sample of 20 EMs’quarterly data during the period of 2002 through 2010. First, we propose a methodology for measuring credit volatility in emerging economies, and use it as the dependent variable in the empirical model. Our independent variable is international capital flows, and we decompose capital flows into four types-Current Account Balance, Foreign Direct Investment, Portfolio Investment and Other Investment-to compare the effects of each type on credit. Our empirical results show that in emerging economies, CAB and FDI are sufficiently negative while PI and 01 are sufficiently positive to domestic credit volatility. We also pay a special focus on the case of China during the period 2000-2012. CAB,FDI and OI are sufficient to explain the long-run effects while PI the short-term effects on credit volatility.When international capital flow into or out of EMs, interactions among monetary policy, fiscal policy and the exchange rate regime can help narrow credit volatility.