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Prepared by Jianping Zhou, Han Fei, and Jasmine Xiao. The authors would llike to thank Dora Iakova, Hibiki Ichiue, Herman Kamil, Robert Rennhack, Alejandro Werner, and seminar participants at the IMF, Secretaría de Hacienda y Crédito Público, and Banco de México for comments and discussions.
For a discussion on U.S. monetary policy uncertainly, see “Fed chiefs debate monetary normalization while Yellen passes off financial stability”, CITI Research, July 11, 2014.
Reforms to the Mexican pension system have strengthened the demand for government securities. The transformation in 1997 of a pay-as-you-go system into an individual contributory pension system for private workers resulted in a surge of large pension funds. Later on in 2007, the pension system of public employees went through a similar reform which further increased assets managed by pension funds, hence stimulating additional demand for securities (see Sidaoui, José, Julio Santaella and Javier Pérez 2012).
An extension of this paper will estimate the impact of mutual funds’ trading behaviors on price volatility.
We use data from the International Monetary Fund’s International Financial Statistics, in which international capital flows are based on the residency criterion of the balance of payments, and cover transactions where one of the counterparties is a resident of the country (say Mexico) and the other a resident of the rest of the world. Capital outflows denote net purchases by domestic residents of financial instruments issued by non-residents, while capital inflows denote net purchases by foreign residents of domestic financial instruments. The difference between capital inflows and outflows (the financial account balance) corresponds to the current account balance (up to a statistical discrepancy).
Forbes and Warnock (2012) defines extreme capital flow episodes using three criteria: (1) current year-over-year changes in four-quarter gross capital inflows or outflows is more than two standard deviations above or below the historic average during at least one quarter of the episode; (2) the episode lasts for all consecutive quarters for which the year-over-year change in annual gross capital flows is more than one standard deviation above or below the historical average; and (3) the length of the episode is greater than one quarter.
Our sample of emerging markets include: Argentina, Bangladesh, Brazil, Bulgaria, Chile, China, Colombia, Croatia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Latvia, Lebanon, Lithuania, Malaysia, Mexico, Morocco, Nigeria, Pakistan, Peru, Philippines, Poland, Romania, Russia, Serbia, South Africa, Sri Lanka, Taiwan Province of China, Thailand, Turkey, Ukraine, Uruguay, and Vietnam.
This is needed since the distribution of the first term is not centered on zero.
For robustness checks, we used (i) the return on the Mexico’s 10-year government bonds (instead of 3-month government bonds), and (ii) the dollar-denominated return on the Mexico’s government bonds.
We use these two episodes as “stress” episodes, because: (i) the height of the Global Financial Crisis (2008Q3–2009Q3) qualifies as an episode of sudden stop, according to the Forbes and Warnock (2012) methodology; and (ii) during the tapering announcement in May 2013, portfolio inflows to Mexico fell, drastically and significantly, two standard deviations below its five year rolling mean.
These papers have not advocated for capital control measures as their desirability and effectiveness are subject to debate, but they supported building up foreign exchange reserve buffers and developing a deep domestic investor base.
The 28 day TIIE interbank equilibrium rate is used as the interbank interest rate to capture domestic monetary policy. The first-order differences of the reserves and interest rates, as well as the first-order differences of log exchange rates are used in the regressions.
Our result is consistent with the finding in the IMF’s Regional Economic Outlook: Western Hemisphere (April 2014) that a shock in VIX (which may reflect global uncertainty) can have diffenrt impact from a shock in US interest rate.
Monetary policy is guided by an inflation targeting framework under a flexible exchange rate, and fiscal policy is anchored by a fiscal responsibility law.
International reserves stand at about US$190bn as of June 2014.