Expectations-Based Capital Inflow Shocks

Abstract

Identifying the impact of capital inflows on output is challenging because inflows are forward-looking and respond to expectations about future economic conditions. We develop a new measure of capital inflow shocks using a simple and broadly applicable expectations-based framework that isolates the unexpected component of inflows by purging movements predicted by professional forecasters’ expectations. Estimates using the new measure for 27 emerging market economies indicate that capital inflows have sizable expansionary effects on output, operating through stronger domestic consumption and investment and easier financing conditions. Additional analysis indicates that equity-type inflows generate greater and more persistent effects than debt-type inflows, while large inflow reversals result in more pronounced effects than comparable increases in inflows. These results are robust to a wide range of alternative specifications.