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The authors appreciate the very useful comments and suggestions received from Roberto Benelli, Nombulelo Duma, Lorenzo Giorgianni, Simon Gray, Roberto Guimaraes-Filho, Adarsh Kishore, Kalpana Kochhar, Scott Roger, Alessandro Zanello, M D Patra, Misa Tanaka, and other seminar participants at the Reserve Bank of India. Souvik Gupta provided outstanding research assistance.
Normalizing the ratios by financial market size (measured as the sum of bank assets, private and public debt securities, and stock market capitalization) would reduce the variation across countries in level of financial globalization but otherwise yield qualitatively similar results: for gross capital flows (respectively, inflows), the correlation of the ratios normalized by GDP and normalized by capital market size are 0.7 and 0.8, respectively, for the subsample of countries for which financial market size data are available.
In Figure 2 and successive charts that show countries on the x-axis, countries are ranked from highest to lowest in terms of their financial openness, measured as gross assets plus liabilities over GDP.
Also, Pasricha (2007) finds that India’s de-facto openness is much higher than its de-jure controls would suggest.
For the market pressure index, we also use weights of 0.8 and 0.2 for the domestic and external component, respectively. Using an alternative measure with equal weights yields qualitatively similar results (see footnote 7).
In the case of India, Kannan, et al (2006) find that the interest rate is more important than the exchange rate in influencing monetary conditions, when accounting for the credit stance. However, for some countries in the sample (e.g., Malaysia), the exchange rate tends to exert equal importance. We therefore also used an alternative measure of MCI with weights of 0.5 and 0.5. Our results remain qualitatively unchanged.
However, we find that the correlation coefficient is negative (higher than 0.5) for the sub-sample of countries with lower levels of financial openness.
Appendix I shows the correlation coefficient between U.S. and domestic monetary conditions and financial openness for other countries in the sample.
Including for example full employment and low exchange rate volatility, in addition to inflation.
If the central bank has an exchange rate target, it will have little control over foreign exchange transactions at least in the short term (volumes will be determined by the market) and may be unable to forecast them accurately. This in turn can undermine control of the central bank over liquidity conditions. If in contrast the central bank uses a tactical interest rate target, and foreign exchange interventions are not expected to influence the exchange rate, the volume is likely to be more controllable by the central bank (see Stevens, 2006, for Australia’s experience pre- and post-floating the exchange rate).
For details on operation of the policy, see: http://www.banxico.org.mx/portalesEspecializados/tiposCambio/didactico/mecanismo_red_acum_reservas.html. Such operations should be grouped with monetary operations in the liquidity forecast (Gray, 2007).
The peso foreign market is sufficiently deep to absorb daily operations (prior to introducing the floating exchange rate, the Bank of Mexico removed all the restrictions imposed in preceding years and encouraged the development of derivatives markets. As a result, daily trading volumes increased 10-fold since 1995). In shallower markets, auctions could be conducted weekly or at a lower frequency. (Relatedly, Turkey engages in preannounced operations to augment its foreign exchange reserves; see Box 2.)
The frequency at which OMOs are conducted can vary from daily (Monetary Authority of Singapore) to weekly (ECB and Bank of England, where the presence of SFs and full reserve averaging lessens the need for daily OMOs). See Table 1. Central banks can also conduct exceptional fine-tuning operations in periods of financial turmoil.
Lending rates, as indicated by the prime lending rate, and deposit rates have been raised, but some banks appear to be reversing this recently in the absence of further policy signals from the RBI.
FX swaps are used by a number of central banks and should not affect the underlying exposure of the market to foreign exchange. They should therefore be grouped with monetary operations in the liquidity forecast (Gray, 2007).
Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Israel, Latvia, Lithuania, Poland, Romania, and Turkey.
Related to this, we find using a different measure of transparency (based on observance of certain principles, as defined in the IMF’s Standards and Codes Gateway), that the overall monetary policy transparency of the least financially open countries in our sample is broadly similar (even slightly higher) than that of the most financially open countries (on average).
Ito, Hiro, and Menzie Chinn (2007).