Silviase/jgov_v1.4_full_ann huggingface dataset:
Net Private Capital Inflows in Selected East Asian Economies

(unit: Billions of US dollars)

1990	1991	1992	1993	1994	1995	1996	1997	1998	1999
Indonesia	4.02	4.40	5.27	5.08	3.70	10.25	11.51	-034	-13.85	-9.92
Direct	1.09	1.48	1.78	1.65	1.50	3.74	5.59	4.50	-0.40	-2.82
Portfolio	-0.09	-0.01	-0.09	1.81	3.88	4.10	5.01	-2.63	-1.88	-1.79
Equity	0.00	0.00	0.00	1.81	1.90	1.49	1.82	-4.99	-4.37	-0.78
Debt	-0.09	-0.09	0.00	0.00	1.98	2.61	3.17	2.36	2.49	-1.01
Others	3.02	2.93	3.58	1.63	-1.68	2.41	0.91	-2.21	-11.57	-5.31
Korea	3.67	7.82	7.92	5.71	11.44	18.07	24.99	-13.65	-13.01	9.58
Direct	-0.26	-0.31	-0.43	-0.75	-1.65	-1.78	-2.34	-1.61	0.62	5.13
Portfolio	0.08	3.05	5.80	10.01	6.12	11.59	15.18	14.30	-1.88	9.19
Equity	0.31	0.21	2.49	6.41	3.23	3.98	5.30	2.21	3.90	11.49
Debt	0.01	2.84	3.31	3.60	2.89	7.61	9.88	12.09	-5.78	-2.67
Others	3.85	5.07	2.55	-3.55	6.397	8.25	12.15	-26.34	-11.75	-4.23
Malaysia	1.82	5.77	8.91	11.37	1.51	7.85	10.04	3.09	0.14	-6.56
Direct	2.33	4.00	5.18	5.01	4.34	4.18	5.08	5.11	2.16	1.55
Portfolio	-0.25	0.17	-1.12	-0.71	-1.65	-0.44	-0.27	-0.25	0.28	0.80
Equity	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00
Debt	-0.26	0.17	-1.12	-0.71	-1.65	-0.44	-0.27	-0.25	0.28	0.80
Others	-0.26	1.60	4.85	7.07	-1.19	4.11	5.23	-1.77	-2.31	-8.92
Philippines	1.18	2.55	0.48	2.20	6.24	5.72	11.89	6.81	0.99	-1.19
Direct	0.53	0.54	0.23	0.86	1.29	1.08	1.34	1.09	1.55	0.63
Portfolio	-0.05	0.11	0.04	-0.05	0.27	1.19	5.32	0.59	-0.88	4.82
Equity	0.00	0.00	0.00	0.00	0.00	0.00	2.12	-0.38	0.08	0.46
Debt	0.01	0.11	0.04	-0.05	0.27	1.19	3.20	0.97	-1.01	4.36
Others	0.70	1.90	0.21	1.39	4.68	3.45	5.23	5.14	0.32	-6.64
Thailand	10.32	11.50	10.09	10.96	12.87	21.86	19.54	-7.92	-15.26	-13.73
Direct	2.30	1.85	1.97	1.57	0.87	1.18	1.40	3.36	6.81	5.87
Portfolio	-0.04	-0.08	0.92	5.46	2.48	4.08	3.54	3.86	-0.04	0.08
Equity	0.44	0.04	0.46	2.68	-0.44	2.12	1.12	3.00	0.15	0.95
Debt	-0.48	-0.12	0.46	2.78	2.92	1.96	2.42	0.86	-0.19	-0.87
Others	8.05	9.74	7.19	3.94	9.52	16.60	14.59	-15.63	-22.03	-19.68

Source: IMF, International Financial Statistics, various issues
As for the equity investment, Korea and Malaysia can be considered as two extreme cases. The equity investment was very active in the case of Korea following the opening up the stock market to foreign investors in 1992. While the bond investment turned to net outflows after the crisis, the equity investment continued to record net inflows and increased drastically in 1999. In contrast, Malaysia did not liberalize its stock market. The cases of Indonesia and Thailand are similar. The equity investment was vitalized after the liberalization of foreign investment in the equity market. However, the reduction in the overall portfolio investment after the financial crisis was much more serious than in the case of Korea.

### 2. Portfolio Investment in Korea

The reading of the statistics on portfolio investment may be misleading because we do not know the amount of domestically issued stocks and bonds bought by foreign investors. The previous table shows that portfolio investment in Korea has been active, at least prior to the crisis, both in the bond and the equity markets. However, a careful look into debt investment reveals that it consists mostly of investment in bonds issued abroad. In fact, most emerging market economies do not have well developed bond markets.

Table 3 reports how much of foreign portfolio investment has been done through domestic equity and bond markets respectively. As expected, the ratio of domestically issued bonds in foreign investment was zero until 1993, and recorded $0.67 billion in 1999. On the other hand, in equity investment, the ratio of domestically issued stocks has been substantial.
(unit: Billions of U.S. dollars)

1990	1991	1992	1993	1994	1995	1996	1997	1998	1999
Portfolio Investment	.32	3.05	5.8	10.01	6.12	11.59	15.18	14.30	-1.88	8.82
Equity Investment	.31	.21	2.49	6.41	3.23	3.98	5.30	2.21	3.90	11.49
Domestic Equity	--	--	--	5.70	1.96	2.20	4.37	.78	3.99	5.62
Debt Investment	.01	2.84	3.31	3.60	2.89	7.61	9.98	12.09	-5.78	-2.67
Domestic Debt	.0	.0	.0	.0	.03	.02	.02	.02	.23	6.7

Source: Bank of Korea, Monthly Economic Survey Bulletin, various issues.

Using Korea as an example, we see that the foreign portfolio investment is affected mainly by factors related to the stock market rather than bond market. The bond investment is significantly affected by the interest rate parity, given risk premium. As far as equity investment is concerned, there is no guarantee for this condition to hold.

Figure 1 provides us with an overview of the relationship between interest rate parity and portfolio investment in Korea. As shown in the first figure (1-1), the domestic interest rate, measured by the corporate bond rate, peaked 15% in December 1997 and began to decrease in the mid-1998. The portfolio investment, on the other hand, has shown an increasing trend since June 1998. The movement of the interest rate and portfolio investment in opposite directions cannot be attributed to the upward adjustment of credibility (i.e., reduction of risk premium).
### 1 -1. Interest Rate and Portfolio Balance

1-2. Stock Price Index and Interest Rate
### 1 -3. Exchange Rate and Interest Rate

(%)

Source: Bank of Korea, Monthly Economic Survey Bulletin, various issues.

The negative relationship between portfolio investment and the interest rate, implied by the figure in the middle (1-2), can be explained by changes in equity investment. The equity investment has shown an increasing trend since mid-1998 in contrast to the decreasing trend of interest rates. If interest rate parity does not hold, we cannot expect the exchange rate to be sensitive to the interest rate gap. As shown in the last figure(1-3), the domestic interest rate and won/dollar exchange rate move in the same direction. This relationship may be interpreted to support the view that capital inflow has been vital in the stock market (Oh (2000)).
### I II. A Small Open Economy Model

In order to highlight the role of capital inflows through the stock market, we expand the Mundell-Fleming model, allowing for that debt and equity are not perfect substitutes. The model is composed of three equilibrium conditions for the goods market, the asset market and the balance of payments.

### 1. The Goods Market

The price level is assumed to be sticky and output is determined by demand. There are four determinants of aggregate demand: consumption, investment, government expenditure, and net exports:

$$ \begin{array}{cccc}+&-&+&+-+\\\end{array} $$

$$ Y=C(Y)+I(i)+G+NEX(sp^{*}/p,Y,Y^{*})\quad:IS\ldots\ldots\ldots\ldots(1) $$

where $ Y(Y^{*}) $ ; domestic(foreign) output C; consumption, I; investment, i; interest rate, G; government expenditure, NEX; net export, s; nominal exchange rate, $ p(p^{*}) $ ; domestic(foreign) price level.

In equation (1), the interest rate and the level of output are inversely related. Thus, the 'IS' schedule, which represents any combination of interest rate and output that satisfy the equilibrium condition in the goods market, is negatively sloped.

### 2. The Assets Market
There are three assets held by risk neutral investors: money(M), domestic bonds (B), and shares in the stock market (S). The two non-money assets are assumed to be imperfect substitutes. In order to derive the equilibrium condition for the asset market, we choose to consider the money market and the stock market. By Walras' law, the bond market is in equilibrium if both the money and stock markets are in equilibrium. Equation (2) is the wealth constraint, and q denotes the real price of a share in stock market.

$$ \mathbf{M}/\mathbf{P}+\mathbf{B}/\mathbf{P}+\mathbf{q}\mathbf{S}=\overline{W} $$

……(2)

The money market is in equilibrium when the demand for money equals the real money supply (M/P). The demand for money is determined by the interest rate, output and the expected real return of a share of the stock market ( $ \rho $ ):

$$ \begin{aligned}\mathbf{M}/\mathbf{P}&=L(i,Y,\rho)\end{aligned} $$

……(3)

Both the interest rate and the expected return of a share have a negative effect on money demand. As the expected return of a share increases, the portfolio of investors will demand increased shares of the stock and therefore will require less money. The expected return of a share in the stock market consists of capital gains and profits (Blanchard (1981)):

$$ \mathsf{\rho}=\Delta\mathsf{q}^{\mathrm{e}}/\mathsf{q}+\pi/\mathsf{q}=\Delta\mathsf{q}^{\mathrm{e}}/\mathsf{q}+(\alpha+\beta\mathsf{Y})/\mathsf{q} $$

In equation (4) $ q^{e} $ denotes the expected price of a share in the next period, and $ \pi $ denotes
the real profit level attained at given level of output.

The rate of return of a share in the stock market is determined by the equilibrium condition, which requires that the total real value of existing shares in the stock market equal that of the demand for shares:

$$ \begin{aligned}&+\text{--}\\ &\\ \mathbf{q}\overline{S}/\overline{W}=V(\rho,\ i,\ i^{*})\\ \end{aligned} $$

The expected rate of return of a share and the domestic and foreign interest rates collectively determine the demand for shares. A rise in the expected rate of return will induce more domestic and foreign investment in the stock market. On the other hand, a rise in the interest rate makes equity investment less attractive. In the case of a rise in foreign interest rate, foreign investors will invest more in their own bond market, resulting in capital outflows.

Equilibrium in the asset market is determined by equations (3) and (5). Because of this, the interest rate on domestic bonds and the expected rate of return of a share in the stock market are simultaneously determined. From equation (3), the expected rate of return is expressed as a function of the interest rate as well as other variables:

$$ \begin{aligned}&+\quad-\\ &\begin{aligned}\\ &\mathsf{\rho}=m(i,\ Y,\ M/P):mm\\ &\end{aligned}\\ \end{aligned} $$

We can derive another relationship between $ \rho $ and i using equation (5). However, the price of a stock share is affected by both $ \rho $ and i so that the relationship between the two is ambiguous. Hence, we need an additional condition on equation (5) to express the rate of return of a share in the stock market ( $ \rho $ ) in terms of the interest rate (i).
This is done by assuming that the expected future price of a share is determined by the domestic and foreign interest rates and output: $ ^{2} $

$$ \begin{aligned}&+\cdots+\\ &\begin{aligned}\\ &q^{e}=h(i,i^{*},Y)\\ &\end{aligned}\\ \end{aligned} $$

..... (7)

A rise in the domestic interest rate has a negative effect on the stock market because a higher interest rate may decrease investment and aggregate demand. An increase in output, however, will boost the profits of firms, which in turn causes an increase in the stock market value. Meanwhile, a rise in the foreign interest rate will have a contractionary effect on the foreign economy thus reducing exports to that economy. The reduction in profits will lead investors to expect a decrease in the stock price.

From equations (5) and (7), it is shown that the current price and the expected price of a share in the stock market move in the same direction in response to changes in domestic and foreign interest rates. How then does the rate of return respond to them? It seems reasonable to assume that a decrease in the domestic interest rate will boost the stock market as well as the expect rate of return in the market. In other words, a change in the expected future price is expected to be more significant than that of the current price. Therefore, the relation between $ \rho $ and i is determined as followed: $ ^{3} $

$$ \begin{aligned}&+\quad+\\ &\quad\\ &\rho=s(i,i^{*},Y):sm\\ \end{aligned} $$

……(8)
Equilibrium values for $ \rho $ and i are then determined by equation (6) and equation (8). As shown in Figure 2, equilibrium in the asset market is determined by the intersection of the ‘mm’ schedule for equilibrium in the money market and the ‘sm’ schedule for equilibrium in the stock market. For purposes of stability, the ‘sm’ schedule should be steeper than the ‘mm’ schedule. $ ^{4} $

Equilibrium in the Asset Market

Using Figure 2, we can easily show that an increase in output will cause an outward shift in both the 'mm' and 'sm' schedules. As a result, both the interest rate on bonds and the expected return of equity rise. Meanwhile, an increase in the money supply will shift only the 'mm' schedule to the left causing a decrease in the interest rate and an increase in the rate of return on equity. Similarly, a rise in the foreign interest rate shifts the 'sm' schedule to the left so that the domestic interest rate increases, and the rate of return on equity decreases.
Using the asset market equilibrium, which satisfies both equations (6) and (8), the equilibrium expected rate of return on a share in the stock market can be expressed as a function of exogenous variables to the financial market:

$$ \begin{aligned}&+\quad+\quad-\\ &\\ \rho=f(Y,\quad M/P,\quad i^{*})\\ \end{aligned} $$

.....(9)

The asset market equilibrium condition can be derived from equations (3) and (9):

$$ \begin{aligned}&+\ -\ -\left(-\ -\ +\right)\\ &\\ M/P&=L(i,Y,s(i,i^{*},Y))\text{：}FM\\ \end{aligned} $$

$$ \mathbf{M/P}=L(i,Y,s(i,i^{*},Y))\text{：}\mathbf{F M}\quad\ldots\ldots\ldots\ldots\ldots(10) $$

From equation (10), we can derive the ‘FM’ schedule, a combination of the interest rate and output that guarantees equilibrium in the asset market. The ‘FM’ schedule is positively sloped. $ ^{5} $

### 3. The Balance of Payments

The external balance denotes that the sum of current account and capital account balances equals zero. If we ignore the transfer payments, the current account balance is identical to the net exports. Thus, the current account balance is determined by the real exchange rate, domestic output and foreign output (see equation (1)). Meanwhile, the capital account balance is affected by domestic and foreign interest rates and the rate of return of a share in the stock market.
$$ \begin{array}{l}+\quad-\quad+\quad\quad\quad\quad+\quad-\quad+\end{array} $$

$$ NEX(sp^{*}/p,Y,Y^{*})+KA(i,\ i^{*},\ \rho)=O\ \cdots\cdots\cdots\cdots(11) $$

Calvo, Leiderman and Reinhart (1996) insist that the equity investment in emerging market economies is sensitive to international interest rates, particularly the U.S. interest rate. According to Bohn and Tesar (1996), on the other hand, the equity investment is considerably affected by its expected rate of return. Moreover, the equity investment depends on the interest rate to the extent that the latter affects the rate of return in the stock market (Bohn and Tesar (1999)). Our specification as of equation (11) fits both observations well.

Replacing $ \rho $ in equation (11) by equation (9), we can derive the equilibrium condition for the balance of payments as follows:

$$ \begin{aligned}&+\quad-\quad+\quad\quad+\quad-\quad+(+\quad+\quad-)\\ &\\NEX(sp^{*}/p,Y,Y^{*})+KA(i,i^{*},f(Y,M/P,i^{*}))=0:\quad BP.....(12)\\ \end{aligned} $$

In equation (12), a rise in the domestic interest rate results in capital inflows. These inflows of capital are minimal because of the underdevelopment of the bond market. Meanwhile, a rise in the domestic output has a positive effect on the capital account balance because it will boost the expected rate of return on equity investment. We assume that the capital account surplus resulting from an increase in output is smaller than the currency account deficit coming from the increased imports. Thus, the net effect of an increase in output on the balance of payments is negative. Therefore, the combination of the interest rate and output for equilibrium in the balance of payments,
which is referred to as the ‘BP’ schedule, is positively sloped.

### 4. Equilibrium of the Economy

The small open economy is in equilibrium when both an internal and an external balance are achieved. In our model, such a condition is represented as a combination of the interest rate and output that satisfies the 'IS', 'FM' and 'BP' schedules simultaneously (point E in Figure 3). Because the capital account balance is insensitive to the interest rate, the 'BP' schedule is drawn steeper than the 'FM' schedule.

Although our model looks identical to the traditional IS-LM-BP model with imperfect capital mobility, there is a significant difference between the two. The 'BP' schedule in the traditional model assumes capital inflows through the bond market. In our model, the equity investment is more crucial than the debt investment. Accordingly, determinants of the expected rate of return in the stock market directly affect the BP schedule. As will be shown in the next chapter, changes in money supply or foreign interest rates shift both the FM and the BP schedule.

Equilibrium of the Small Open Economy
### I V. Macroeconomic Policy and External Shocks

### 1. The Monetary Policy

Monetary expansion shifts both the ‘FM’ and the ‘BP’ schedules. An increase in the money supply lowers interest rates so that the ‘FM’ schedule shifts to the right. Meanwhile, monetary expansion boosts the expected rate of return on equity, inducing capital inflows into the stock market. Thus, the ‘BP’ schedule also shifts to the right.

The short-run equilibrium, which implies the simultaneous equilibrium of both the goods and the financial market, is determined at Es in Figure 4. Compared with initial equilibrium, the economy now has a lower interest rate, but a higher income level. The lower interest rate causes an outflow of capital, while the higher output and higher expected return of equity induce the inflow of capital. Therefore, the net effect on capital inflows in the short-run equilibrium (Es) is ambiguous. We assume that the shift in the 'BP' schedule is greater than that in the FM schedule because the BP curve is insensitive to a change in the interest rate. Therefore, it is highly probable that the overall balance at Es becomes a surplus.

Under the flexible exchange rate regime, the surplus of balance of payments at Es causes the domestic currency to appreciate. Therefore, both the 'IS' schedule and the 'BP' schedule shift to the left. The long-run equilibrium occurs at $ E_{L} $ , as shown in Figure 4. Monetary expansion has an expansionary effect on output in the short-run, but the appreciation of exchange rates offsets it, at least partially. Therefore, we are unable to determine the overall income effect of an expansionary monetary policy. Meanwhile, the balance of payments remains a surplus during adjustment from $ E_{L} $ .
Expansionary monetary policy under the flexible exchange rate regime

Expansionary monetary policy: the Fixed Exchange Rate Regime

To summarize, an increase in money supply has an expansionary income effect in the short-run but its long run effect on income is not clear owing to the appreciation of exchange rates. That is, monetary policy can be ineffective in stabilizing the economy.
This finding contradicts the result attained in the Mundell-Fleming model on efficacy of monetary policy under the flexible exchange rate regime.

Now, let us consider the case of the fixed exchange rate regime. As shown in Figure 5, the short-run equilibrium, after an increase in monetary supply, is the same in the case of the flexible exchange rate regime. In order to maintain the fixed rate, however, monetary authorities should intervene in the market. As a result, there will be money supply expansion that leads to another round of the balance of payments surplus and an increase in the money supply. Both the BP and the FM schedules will shift to the right. As the effects of the money supply shock on the expected rate of return of equity gradually diminish, the size of the balance of payment surplus becomes smaller. Eventually, the long-run equilibrium occurs at $ E_{L} $ in Figure 5. Comparing Eo and $ E_{L} $ , we may conclude that monetary policy is an effective instrument for stabilization in the case of fixed exchange rate regime.

### 2. The Fiscal Policy

In order to examine the effects of fiscal policy on income, we increase government expenditures, g in equation (1). An increase in g shifts the 'IS' schedule to the right so that the short-run equilibrium is determined at Es in Figure 6. At Es, the balance of payments becomes a deficit. Under the flexible exchange rate regime, the domestic currency depreciates. Accordingly, both the 'IS' and the 'BP' schedules shift to the right. The long-run equilibrium is achieved at $ E_{L} $ . At $ E_{L} $ , income is much higher than the initial level. Unlike the Mundell-Fleming model, fiscal policy turns out to be effective under the flexible exchange rate regime.
Now, let us consider the case of the fixed exchange rate regime. As in the case of flexible rates, an expansionary fiscal policy leads to a higher income, a higher interest rate, and the balance of payments deficit. To maintain the fixed rate, the monetary authorities must sell foreign exchanges. The following reduction of money stock causes both the FM and BP schedules to shift to the left. In the long-run, the economy reaches the new equilibrium, $ E_{L} $ , where the income level is much lower than it is at $ E_{S} $ . The overall effect of fiscal policy on income, however, is indeterminate.

Expansionary Fiscal Policy: the Flexible Exchange Rate Regime
Expansionary Fiscal Policy: the Fixed Exchange Rate Regime

### 3. Increase in World Interest Rates

A sudden termination of capital inflows or large capital outflows would have a considerable impact on the economy if the stock market were completely open to foreign investors. As surveyed in Chapter 2, portfolio investment in equity is sensitive to global factors so that the ability of domestic policy authorities to secure stable capital flows is limited. In this sense, it is important to study the causes and effects of abrupt changes in capital inflows. Here, we consider the rise in world interest rates for that purpose.

The increase in world interest rates $ (i^{*}) $ in equation (9), leads to capital outflows and a leftward shift of the ‘FM’ schedule. Simultaneously, the ‘BP’ schedule shifts to the left. It may be reasonable to assume that the ‘BP’ schedule shifts to a greater degree than the ‘FM’ schedule because the insensitivity of capital account to the domestic interest rate requires a larger increase in the domestic interest rate to offset capital outflows in the
capital account. Nevertheless, the overall balance is expected to be in deficit in the short-run equilibrium (Es in Figure 8), while the income level decreases and the domestic interest rate increases.

Under the flexible exchange rate regime, the deficit in the balance of payments depreciates the domestic currency, shifting both the 'BP' and the 'IS' schedules to the right. The long-run equilibrium occurs at $ E_{L} $ . The rise in world interest rates has a contractionary effect on the economy in the short-run, but this effect is mitigated due to the depreciation of domestic currency in the long run. Therefore, the flexible exchange rate works as a shock absorber against a rise in world interest rates. In the long-run, domestic interest rates also get upwardly adjusted in response to a higher world interest rate.

Under the fixed exchange rate regime, the balance of payments deficit in the short-run results in a decrease in the money stock. As shown in Figure 9, the 'FM' and the 'BP' schedules shift to the left as the money supply decreases. In the long-run, the economy arrives at equilibrium as shown in $ E_{L} $ . In this case, the short-run contractionary effect of a rise in world interest rates gets aggravated in the long-run. The reason is simple. The exchange rate cannot function as a shock-absorber in the fixed exchange rate regime so that income alone should absorb the shock. In this sense, the flexible exchange rate regime is better than the fixed exchange rate regime in coping with external shocks originating in the global financial market.
Increase in World Interest Rates: the Flexible Exchange Rate Regime

Increase in World Interest Rates: the Fixed Exchange Rate Regime