Collateral Consequences, Capital Flows, and Commodity Prices

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Collateral Consequences

Vincent Reinhart

Vincent Reinhart - Chief Economist & Investment Strategist

The trip to the extreme lower bound of nominal policy interest rates and experiments with other unconventional policies by the major central banks was designed to help at home. The collapse of asset prices, the locking shut of intermediation, and impairment of confidence threw a massive adverse hit to aggregate demand when, in many of these countries, fiscal policy was hamstrung. These monetary policy actions were not coordinated but emulated by officials dealing with circumstances on the ground. While all policy is local, it can have global consequences. Sometimes the best place to see this is by noticing an absence. In this case, notably absent is elevated distress in emerging-market sovereigns and domestic high-yield debt despite a confluence of adverse economic circumstances.

This is what my coauthors (Carmen Reinhart and Christoph Trebesch) and I do in a paper presented earlier this month at the eighteenth annual research conference of the International Monetary Fund (available here). The title, "Capital Flow Cycles: A Long Global View," conveys the research strategy. We gathered data on as many countries as we could, both advanced and emerging market economies, back to 1815 on capital flows. We compared aggregate flows to an index of real commodity prices and the real short-term interest rate at financial centers, recognizing that the gravitational forces of global finance had multiple and shifting poles over two centuries. We also argue that the policy of the financial center should be judged in terms much broader than its real short-term interest rate. It takes about 85 pages (not counting the additional appendices) to work through data assembly and analysis but the core results—two recent anomalies about relative economic growth and finance—show through aggregates gotten from the latest World Economic Outlook of the International Monetary Fund over the relatively brief span since 1980.

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