ep BANCA D'ITALIA

EUROSISTEMA
WY)

Bank of England - Banque de France - IMF - OECD - Banca d'Italia
Ath Joint Workshop on international capital flows and financial policies

Introductory Remarks by Luigi Federico Signorini
Senior Deputy Governor, Banca d'Italia

Rome, 6 October 2023

Ladies and Gentlemen,

It is with great pleasure that I welcome you to the 4th Joint Workshop on International
Capital Flows and Financial Policies, organised by the Bank of England, Banque
de France, the International Monetary Fund (IMF), the Organisation for Economic
Cooperation and Development (OECD) and Banca d'Italia.

Current developments are raising a number of important, and sometimes new, issues
in the field.

If one looks at the monetary tightening cycle that is ongoing in the major advanced
economies, while there is clear evidence of increased bond outflows from emerging
market economies, and of some pressure on their currencies, the fact is that so far
global financial markets have seen nothing as disruptive as during past episodes
of global tension, such as the financial crisis of 2008-2009 and, though to a lesser
extent, the taper tantrum of 2013.

There are several possible explanations for this. They include sounder macro policies
by EMEs leading to fewer imbalances, deeper internal financial markets, and a better
emergency management of capital flows. On the last point, to quote but one piece of
evidence, a joint Bank of Italy-Bank of England working paper' showed that, during the
Covid-19 sudden stop, emerging markets engaged in the coordinated deployment
of several tools (monetary, fiscal and macroprudential), and policy actions were by
and large effective. This suggests (among other things) that a number of EMEs have
adopted insights from the IMF's institutional view and from the Integrated Policy
Framework. In various ways, many of them have become more mature, as well as
richer.

1 F. Eguren Martin, M. Joy, C. Maurini, A. Moro, V. Nispi Landi, A. Schiavone and C. van Hombeeck (2020),
'Capital flows during the pandemic: lessons for a more resilient international financial architecture', Banca
d'Italia, Questioni di Economia e Finanza (Occasional Papers), 589.

While this is one piece of encouraging news, generally speaking, multiple, significant
changes in the landscape of international capital flows are leading to several new
challenges. Looking ahead, I see at least three major ones.

The first is the risk of financial fragmentation, which came to the fore after Russia's
invasion of Ukraine wreaked havoc on the world economy (and much else). The
ensuing geopolitical tensions have intensified concerns about the danger of a more
economically and financially fragmented world, and of a diminished role for the G20
and other multilateral fora and institutions. In a recent Global Financial Stability Report,
the IMF estimated that a one-standard-deviation increase in geopolitical tensions
between an investing and a recipient country would reduce bilateral cross-border
capital flows by about 15 per cent.* In the long term, financial fragmentation would
limit the market liquidity of international assets and liabilities and put constraints
on the opportunities for cross-border diversification, ultimately increasing the
vulnerability of economies to adverse shocks.

The second challenge is climate change, which is already causing an increase in
the frequency and intensity of natural disasters, and in the size of climate-related
damage. Seen from the specific perspective of today's discussions, natural disasters
may conceivably influence international capital flows to and from the affected
countries through various channels, though the overall sign of the effect is unclear.
In principle, natural disasters can be expected to cause higher capital inflows, if
the marginal product of capital increases as a consequence of a reduction in the
capital stock. However, if a natural disaster also affects complementary inputs, such
as infrastructure and human capital, or shrinks the total factor productivity of firms
by delaying or cancelling investments in new technologies,? the return to physical
capital might decrease instead of increasing, inducing no inflows or even outflows.

A third prospective driver of international capital flows is payments technology.
Governments and international institutions are currently devoting a lot of activity to
improving cross-border payments, while private-sector initiatives are also increasing.
From our point of view, one especially interesting topic is the Central Bank Digital
Currency (CBDC) infrastructures currently being envisaged in various jurisdictions.
Specifically, wholesale CBDCs can be a way to increase the efficiency of cross-currency
transactions, by shortening transaction chains and addressing frictions in cross-
border funding arrangements.° Ideas are being discussed about ways to link CBDC

2 Geopolitical risk is computed in terms of the diverging voting behaviour of the United States and China
in the United Nations since 2016; see IMF (2023), Safeguarding financial stability amid high inflation and
geopolitical risks. GFSR, April 2023.

3. World Bank (2021), Global Productivity: Trends, Drivers, and Policies, chapter 3, 'What happens to
productivity during major adverse events?'.

4 BIS, IMF, and WB (2022), Options for access to and interoperability of CBDCs for cross-border payments,
Joint report to the G20.

5 Panetta, F. (2022), 'Demystifying wholesale central bank digital currency'. Speech at the Symposium
on 'Payments and Securities Settlement in Europe - today and tomorrow' hosted by the Deutsche
Bundesbank.

infrastructures in different jurisdictions. There is, indeed, much room for improvement
compared with the current situation.

All of these topics will be discussed in today's workshop. Let me now give you a short
outline of the programme.

The first session is devoted to climate-related transition risk and sanctions. Maximilian
Konradt (Geneva Graduate Institute) will present evidence of the way institutional
investors adjust their exposure to a country that tightens its climate policy-a topic
of great interest to Bank of Italy researchers.® Massimo Ferrari Minesso (ECB) will then
explore the way trade and financial sanctions affect the exchange rate, looking at
data from the first half of the twentieth century, spanning two world wars.

The second session will focus on digital currencies. Maurizio Michael Habib (ECB)
will analyse the drivers of Bitcoin transactions vis-a-vis a sample of fiat currencies,
highlighting the financial stability risks of a widespread adoption of cryptocurrencies.
Michael Kumhof (Bank of England) will present a two-country DSGE model in which a
central bank digital currency competes with other forms of money, comparing several
CBDC policy rules. The effects of introducing a CBDC into a large economy is also a
prominent topic of current research at the Bank of Italy."

After the lunch break, Christoph Trebesch (Kiel Institute) will give a keynote speech on
how geopolitics and war shape international financial flows. This speech will directly
address one of the main challenges that I have just listed, including a discussion of
the all-important issue of the consequences for financial stability.

The third session of the workshop will explore the role of the dollar in the international
monetary system. Steve Wu (UCSD) will present a model to explain episodes of
appreciation of the dollar and capital flow reversal during crises. Alexandra Tabova
(IMF) will use a novel database to shed light on investors' behaviour in the market for
US treasury bonds. The role of the dollar in shaping the global financial cycle is also,
of course, a central topic in the Bank of Italy's research agenda.®

Next, we shall have a policy panel with Robin Brooks (Chief Economist at the Institute
of International Finance), Ayhan Kése (Deputy Chief Economist at the World Bank
Group), Clara Raposo (Vice-Governor of the Bank of Portugal), and Francis Warnock
(University of Virginia). The panel will first discuss the short-term drivers of capital
flows, focusing in particular on the implications of the current monetary policy

6 See for instance F. Ferriani, A. Gazzani and F. Natoli (2023), 'Flight to climatic safety: local natural disasters
and global portfolio flows', Banca d'Italia, Temi di Discussione (Working Papers), 1420.

7 See for instance P. Cova, A. Notarpietro, P. Pagano and M. Pisani (2022), 'Monetary policy in the open
economy with digital currencies', Banca d'Italia, Temi di Discussione (Working Papers), 1366 and A. Moro,
V. Nispi Landi (2022), 'The external financial spillovers of CBDCs', Banca d'Italia, Temi di Discussione
(Working Papers), 1416.

8 See for instance M.M. Habib, L. Stracca and F. Venditti, (2020), 'The fundamentals of safe assets', Journal
of International Money and Finance, 102, 102119 and I. Buono, F. Corneli, E. Di Stefano (2020), 'Capital
inflows to emerging countries and their Sensitivity to the global financial cycle', Banca d'Italia, Temi di
Discussione (Working Papers), 1262.

tightening cycle. Next, the panel will explore a longer-term perspective, addressing
the implications and policy considerations associated with the impact of climate
change and of transition risk on capital flows.

The final remarks will be made by Dennis Reinhardt of the Bank of England, which will
host the next edition of the workshop.

In closing, I wish to express once again the Bank of Italy's deep appreciation for your
presence and active participation. I am sure this workshop will result in much fruitful
interaction and discussion.