Essays in International Finance and the Political Economy of Capital Flows

Abstract

The integration of global financial markets is a double-edged sword, paving the way for increased growth and cooperation while also sowing the seeds for notoriously destabilizing sudden stops and currency crises. This dynamic has generated academic and practitioner interest in studying the causes of capital flow cycles and factors which may help insulate countries from exposure to negative financial shocks. In this dissertation I examine how countries respond to and manage sudden surges in capital and the channels which encourage greater international flows. I analyse these patterns with both macroeconomic and firm-level measures of engagement in global capital markets. The first chapter examines how responsive global capital markets are to elections, partisanship and executive turnover. Using quarterly data for a panel of emerging market and advanced economies from 1987-2018, I find sudden stops in gross foreign capital flows are more likely in quarters preceding national elections. Consistent with hypotheses on capital flows responding to policy uncertainty, I find this positive relationship is strongest for elections that exhibited a partisan switch, with a predicted increase in stop onset from 12% to 20%. I then examine how adjustments in macroprudential regulation evolve around capital flow episodes and how this relationship is mediated by the relative independence of central banking authorities. After experiencing a capital surge, states with low levels of central bank independence are less likely to tighten macroprudential regulations, while states with higher levels of central bank independence exhibit a higher likelihood of tightening. These results contribute to our understanding of when governments may react to financial inflow bonanzas with regulations that serve to lean-against-the-wind and may prevent or cushion future hard landings. The second chapter studies another management tool in the form of international reserves. For many analysts, a large war chest of international reserves is seen as a prudent means of self-insurance, but holding reserves comes at the cost of limiting monetary expansion and can be politically costly during election periods. I argue the dynamics of this political business cycle of reserve accumulation fundamentally change depending on whether a country is experiencing large inflows of foreign capital. During foreign inflow surges, failure to accumulate adequate reserves can generate a real appreciation of the exchange rate, destabilizing the exchange rate and eroding the competitiveness of export sectors. I find prevailing foreign capital availability and election timing interact to modify previously documented political business cycle relationships between reserve growth and election timing. During capital inflow surges, the predicted change in country-level reserve growth rates in election windows is a 0.15 standard deviation increase, while no significant changes are observed around elections in the absence of large prevailing foreign inflows. The final chapter is a joint work with Taehoon Kim. In this chapter we turn to a source of foreign capital flows from the corporate sector and examine theoretical motivations for firm-level decisions to invest and operate in foreign jurisdictions. Using survey data collected by the US Bureau of Economic Analysis on both the intensive and extensive margins of the activities of US multinational companies (MNCs) and their foreign affiliates, we estimate the impact of MNC operations on the persistent spread between the return on assets (ROA) and the interest rate payments of firms. Our evidence indicates MNCs enjoy a 0.9% larger spread between ROA and average interest rate compared to when these same firms did not have large ownership holdings in foreign affiliates. We then introduce a model of MNC activity which can disentangle potential mechanisms to explain this spread and estimate the implied ‘FDI Restrictiveness’ of different regions based on observed patterns of foreign investment. Our simulations suggest some of the variation in firm performance can be accounted for by the incomplete integration of global financial market. These results highlight the role of US multinationals as global arbitrageurs in addition to being global risk-takers.