Essays in International Finance and the Political Economy of Capital Flows
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Kearney, Casey
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Kearney, Casey. 2023. Essays in International Finance and the Political Economy of Capital Flows. Doctoral dissertation, Harvard University Graduate School of Arts and Sciences.Abstract
The integration of global financial markets is a double-edged sword, paving the way forincreased 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.
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