Pull, Push, Pipes: Sustainable Capital Flows for a New World
Order
Speech given by
Mark Carney
Governor of the Bank of England
Institute of International Finance Spring Membership Meeting, Tokyo
6th June 2019
I am grateful to Daisy McGregor and Simon Whitaker for their assistance in preparing these remarks,
and to Fernando Eguren Martin, Lukas von dem Berge, Carlos Van Hombeeck, Simon Lloyd,
Ambrogio Cesa-Bianchi, Nitya Aasaavari, Delma Essel, Sameeta Thakrar and Wayne Chapman for
research and analysis. The research presented in this speech will be detailed in a forthcoming Bank
of England working paper.
I would like to speak today about your raison d'etre: sustainable cross border
It is a pleasure to be at the IIF.
capital flows.
Capital flows can be an enormous force for good. For example, when my native Canada was an emerging
economy, net capital inflows averaged 10% of GDP every year for around three decades.
But the recent history of capital flows is more chequered.
After all, the IIF was founded 36 years ago in response to the Latin American debt crisis. That crisis was the
- -
product of an initially well founded and productive but ultimately over exuberant and destructive recycling
of petro dollars by the banking system.
That period provided painful examples both of how capital flows can support development and how capital
flow volatility can undermine it.
The Asian crisis almost 15 years later underscored the risks of relying on inflows that look stable but prove
ephemeral. And subsequent crises in Latin America around the turn of the millennium and in advanced
economies (AEs) a decade ago reinforced the risks of taking capital flows for granted.
In theory, foreign capital inflows should support growth through greater allocative efficiency, better risk sharing
and increased technology transfer.
But in reality financial openness has proven a double-edged sword. The typical emerging market economy
(EME) receiving higher capital inflows will grow 0.3 percentage points faster, all else equal (Chart 1). But the
typical EME with higher capital flow volatility will grow 0.7 percentage points slower
(Chart 2).1
Charts 1 and 2: Financial openness is a double-edged sword
9
9
(%)
(%)
growth
growth
GDP
GDP
Real
Real
876543210
876543210
0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Capital flows as % GDP Volatility of flows
Source: IMF.
Notes: Volatility is the coefficient of variation of gross inflows scaled by external liabilities. Real GDP growth, gross inflows to GDP and
volatility are averaged over 1970 to 2017 for 38 emerging market economies.
1
Comparison is between medians for the high and low groups of the sample shown in Chart 1 and 2, with high and low groups defined
as those above and below medians of the sample.
Time and again, waves of investment into EMEs are sharply withdrawn (Chart 3). And more generally,
financial openness has tended to amplify domestic imbalances and leave EMEs more vulnerable to foreign
shocks.2
As a consequence, a fifth of all surges in capital flows to EMEs have ended in financial crises. And EMEs are
at least three times more likely to experience a financial crisis after capital flow surges than in normal times.3
Chart 3: Net private capital flows to emerging market economies and incidences of crises
% of GDP Number of EM crises (rhs)
Number
Net private capital flows to Non-China EMEs (lhs)
6
6
Crises tend to occur
5
5
when capital flows slow
4
4
3
3
2
2
1
1
0
0
-1
1980 1985 1990 1995 2000 2005 2010 2015
Source: IMF. Notes: Excludes China.
Chart 4: Financial openness
External liabilities as % of GDP
300
250
200
150
Advanced economies
100
50
Emerging market economies
0
1980 1985 1990 1995 2000 2005 2010 2015
Sources: IMF International Financial Statistics and Lane Milessi-Ferretti (2007) External Wealth of Nations dataset.
2
For a recent summary of all the literature on the factors affecting capital flows to EMEs see Keopke (2019), What drives capital flows to
emerging markets? A survey of the empirical literature, Journal of Economic Surveys.
3
Ghosh et al (2016), When do capital inflows surges end in tears?, American Economic Review. Surges are defined as a net capital
and the full sample's distribution of net capital flows,
flow observation that lie in the top thirtieth percentile of both the country-specific
expressed in percent of GDP.
Given the uncertainty over the sustainability of capital inflows, EMEs have defensively accumulated reserves
and limited the opening of their capital accounts, including by resorting to overt capital flow management in
some cases. Overall, EMEs have increased their financial openness by considerably less than advanced
economies (AEs) since 1980, leaving their external balance sheets only around a third the size of those in
AEs, despite much faster growth in external trade (Chart 4).
These responses, while understandable, carry significant opportunity costs. Excess precautionary savings in
EMEs are pushing down equilibrium interest rates, increasing the risks of a global liquidity trap. And
enormous cross border flows will be required to close EME infrastructure investment gaps and to finance the
essential transition to a low carbon economy.
Today, I want to examine what drives capital flow volatility and, in the process, sketch an agenda for
sustainable capital flows in the new world order.
Specifically, what should be the priorities to increase sustainable cross border capital flows? How many are
the responsibility of the receiving country? What about the advanced economies who set the tone for the
global financial cycle? And to what extent does the structure of the international monetary financial system
itself, including the global safety net, determine safe flows?
begin to answer these questions, the Bank of England is developing a holistic "Capital
To Flows-at-Risk"
framework that assesses the relative contribution of the three drivers of Capital Flows-at-Risk:4
 'Pull factors' -
domestic conditions and institutions that affect the relative attractiveness of investing in an
individual country.
'Push factors' -
 that determine global risk appetite and financial conditions, particularly the level and
prospects for US monetary policy and financial stability.
 'The Pipes' - the structure of the global financial system itself, particularly the degree to which it dampens
or amplifies shocks.
4
This builds on early work by the IMF presented in the October 2018 Global Financial Stability Report relating to portfolio flows. More
details on the Bank of England work will be forthcoming in a Working Paper.
Chart 5: The distribution of capital flows to emerging market economies
Probability density
Unconditional distribution Negative shock
0.10
0.08
0.06
0.04
A
B
0.02
0.00
-8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18
Capital flows as a % of GDP
Sources: IMF and Bank of England staff calculations.
Notes: This chart shows the unconditional distribution of capital flows to EMEs over 2006-2018, and an estimated
distribution conditional on a one standard deviation negative shock to pull factors. The diamonds highlight the fifth
percentile, which is our preferred measure of Capital Flows-at-Risk. We estimate several quantiles of the distribution
through quantile regression and then fit a skewed-t distribution; hence, the distribution can both shift and change shape
in response to shocks - see annex for further details.
The grey line in Chart 5 shows the unconditional distribution of capital flows, and the purple line shows how
"Capital are
the distribution shifts in response to a negative shock. Flows-at-Risk" defined as capital outflows
in a severe, low-probability event (that with 5% probability or less). The left tail 'fattens' if bad outcomes
-
become more likely and/or the "5% probability event" becomes more severe shown by the shift from A
(Capital Flows-at-Risk of 1.2% of GDP) to B (Capital Flows-at-Risk of 4.2% of GDP).
The Bank's framework can be used to assess policy options and associated
trade-offs, and to communicate
policy decisions.
Today, I will provide some tentative conclusions in order to spur further debate and analysis, including as part
IMF's work on its "Integrated Framework" and
of the Policy the G20 discussions on the future of the financial
architecture.
Our core finding is that the distribution of capital flows will shift and change shape when there is a change in
- -
any of the three drivers pull, push or pipes.5 In an interdependent world, everyone advanced economies,
5
model presented in chart 6 does not explicitly model 'the pipes'. The impact of augmenting
The Capital Flows-at-Risk
the framework with pipes is shown later on in charts [15 and 16].
-
emerging economies as well as the public and private sectors is responsible for reducing capital flow
volatility and increasing sustainable capital flows in order to meet the challenges of our age.
Turning to the three drivers in more detail.
Pull factors
The conventional wisdom, prior to the financial crisis, was that the best contribution each country can do for
to "keep its own house in order".6
itself and others would be
The foundations of that house are:

Credible inflation targeting regimes. Credible domestic frameworks for implementing monetary policy
- -
with an operationally independent and accountable central bank at their core have generally
delivered inflation rates that are both lower and less variable.7 This directly benefits all citizens in
good times. Moreover, greater monetary policy credibility gives a central bank more scope to respond
to shocks, and enables financial markets to anticipate better the path for monetary policy, thereby
providing a stabilising force during bad times. During the taper tantrum, those economies with better-
anchored inflation expectations were able to keep monetary policy relatively more accommodative.8

Flexible exchange rates. A flexible exchange rate acts as a valuable shock absorber for an economy
because domestic wages and prices are relatively "sticky" (in other words, slow to adjust). For
example, suppose there is a spike in global risk aversion. As capital flows are withdrawn flexible
general, this boosts an economy's competitiveness. However, where
exchange rates depreciate. In
economies borrow heavily in foreign currency, and this exposure is unhedged, depreciations can be
detrimental for the economy.9
 Fiscal sustainability. A sustainable fiscal position provides governments with more room to respond to
adverse shocks to demand. Financial markets therefore reward more sustainable fiscal positions: the
IMF found that declines in inflows between 2010 and 2015 were 1 percentage points of GDP larger for
countries with above-average public debt ratios.10 Fiscal sustainability is also necessary for a credible
nominal anchor.
6
Fischer, S (1988), International Macroeconomic Policy Coordination, in International Economic Cooperation, ed. by Martin Feldstein,
Chicago: University of Chicago Press.
7
Rose (2007), A stable international monetary system emerges: Inflation targeting is Bretton Woods, reversed, Journal of International
Money and Finance, Elsevier, vol. 26(5), pages 663-681, September.
8
See Chapter 3 of the October 2018 IMF World Economic Outlook.
9
Cesa-Bianchi et al (2015), Global Liquidity, House Prices, and the Macroeconomy: Evidence from Advanced and Emerging Economies,
Journal of Money, Credit and Banking, show that for AEs flexible exchange rates dampen the impact of push shocks, whereas for EMs
they can amplify the impact of push shocks via a collateral valuation effect
10
See Chapter 2, IMF April 2016 World Economic Outlook.

An effective macroprudential policy toolkit to curtail the damaging extremes of domestic financial
cycles. Macroprudential policy can guard against rapid credit growth, which is amongst the best early
warning indicators of an impending downturn.11 And higher domestic bank capital ratios reduce the
sensitivity of capital inflows to changes in global volatility.12

And deep domestic capital markets to reduce the reliance on foreign investors and the need to issue
in foreign currency, which dampens capital flow volatility (Chart 6).
Chart 6: Correlation of capital flow volatility and the share of FX-denominated corporate debt
Volatity of capital flows
2.0
ZAF
RUS
1.5
KOR
IDN
CHL
THA
MYS
TUR
1.0
ARG
MEX
ISR
BRA
POL
CZE
CHN
COL
IND
0.5
0.0
0 10 20 30 40 50
corporate
Share of non-financial debt denominated in USD
Sources: IMF and IIF.
Notes: Measured as coefficient of variation of gross inflows scaled by external liabilities.
11
For example, see Bridges, J, Jackson, C, McGregor, D (2017) Down in the slumps: the role of credit in five decades of recessions,
Bank of England Staff Working Paper N. 659; Borio, C, Drehmann, M, Xia, D (2018) The financial cycle and recession risk, BIS quarterly
review; Taylor, A, Schularick, M (2012) Credit Booms Gone Bust: Monetary Policy,
Leverage Cycles, and Financial Crises, 1870-2008, American Economic Review and Cesa-Bianchi, Eguren Martin, Thwaites, (2019),
Foreign booms, domestic busts: The global dimension of banking crises, Journal of Financial Intermediation, Elsevier.
12
-
Hoggarth, G, Jung, C. and Reinhardt, D. (2016) Capital inflows the good, the bad and the bubbly. Bank of England Financial
Stability Paper No. 40.
Chart 7: Improving Pull Factors have reduced Capital Flows-at-Risk
Capital Flows-at-Risk as a % of GDP
2
Average Capital Flows-at-Risk Contribution of pull factors
inflows
Gross
0
outflows
Gross
-2
-4
1996 1999 2002 2005 2008 2011 2014 2017
Sources: IMF and Bank of England staff calculations.
Notes: The grey bars on this chart show the unconditional 5th percentile of the distribution of capital flows in a panel
of 13 EMEs since 1996. The purple bars build on the contribution of pull factors to the conditional 5th percentile of
capital flows in the current quarter and two quarters ahead. Pull factors are proxied by domestic financial condition
indices (DFCIs), which are mean-orthogonalised by a global financial conditions index (GFCI). The coefficient on the
DFCIs is estimated by panel quantile regressions. The chart shows PPP-weighted averages across the 13 EMEs in
our panel. See Annex for further details.
Bank of England's analysis finds that the conventional prescription to concentrate on putting one's own
The
house in order had merit: pull factors were the main drivers of capital flow instability prior to the 2008 crisis
(Chart 7). Over the years, this advice has been taken to heart.13
80% of EMEs are now inflation-targeters, compared to none just prior to the Asian Financial Crisis. These
regimes have generally been successful: inflation has been low and stable across EMEs since the mid-2000s
at a median rate of 2.5%, close to the rate in AEs. In many respects, the exceptions such as Argentina and
Turkey prove the norm.
Fiscal policy is more of a mixed picture; debt ratios are lower than in advanced economies but fiscal deficits
have widened materially in recent years.
In general, the resilience of emerging economy banking systems has increased with implementation of most of
the FSB post-crisis reforms on track. EMEs are the most active users of macroprudential policy.
13
In the model pull factors are proxied by domestic financial conditions (mean-orthogonalised by global financial conditions), which
encompass market views about domestic institutional frameworks.
-
However, while there has been progress in developing domestic capital markets the depth of EME financial
-
markets has doubled since the turn of millennium this has been insufficient to meet rising financing needs.
As a result, the share of FX-denominated debt has increased sharply (Chart 8).
And while domestic markets have deepened, the share of foreign ownership in EME local currency bond
markets has risen, up from 5% on average pre-crisis to around 25% today.
Chart 8: EM foreign currency debt as a share of GDP
Per cent of GDP
22
21
20
19
18
17
16
15
14
13
12
95 97 99 01 03 05 07 09 11 13 15 17
(a) Excludes China, non-bank borrowers only.
Sources: IIF and BIS.
the Bank's analysis finds that, for
Despite these vulnerabilities, EMEs as a whole, reforms to domestic
institutional "pull factors" have substantially increased the sustainability of
capital flows and so shifted the
distribution of capital flows to the right (Chart 9), all else equal.
Chart 9: Pull factors have reduced Capital Flows-at-Risk for EMEs since the Asian Financial Crisis
Probabilty density
0.12
0.10
0.08
0.06
0.04
B
A
0.02
0.00
-8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18
Capital flows as a % of GDP
Post-2008 2008-2018 crisis Asian Financial Crisis
Sources: IMF and Bank staff calcluations.
Notes: Chart shows the contribution of pull factors to capital flows to EMEs during the Asian Financial Crisis (purple),
and since 2008 (green). In both distributions push factors are held at their sample average, so only pull factors are
changing. See chart 5 and annex for further details.
Push factors
been equal. The importance of has increased over time
Unfortunately for EMEs, all else has not "push factors"
as monetary policy and financial stability shocks in advanced economies have become both more prevalent
and more potent.
And push factors are arguably becoming more important as the fundamental asymmetry at the heart of the
global economy deepens.
When the IIF was founded, EMEs made up a little more than 1/3 of global GDP. Since the last Fed tightening
cycle, their share of global activity has risen from around 45% to 60%. By 2030, it is projected to rise to
around three quarters.
But while the real global economy is being reordered, the international monetary financial system has barely
begun its transition. The dollar represents the currency of choice for at least half of international trade
invoices, two-thirds of global securities issuance, it denominates two-thirds of EME foreign currency external
debt and acts as the monetary anchor in countries accounting for 70% of global GDP.14
14
Gopinath, Gita, and Jeremy C. Stein. (2018) Banking, Trade, and the Making of a Dominant Currency, Working paper, Harvard
University, Cambridge, MA. Gourinchas, P, Rey, H Sauzet, M (2019), The International Monetary and Financial System, NBER
Working Paper No. 25782.
In fact, the dollar is as dominant today as it was during the Bretton Woods era, and is likely to remain so for
some time, as its roles in international payments, as a reserve asset and a funding currency are mutually
15
reinforcing.
This means developments in the US have disproportionate influence on global economic and financial
conditions. Indeed, our research suggests that the influence of US financial conditions on foreign GDP has
increased by a third relative to its average from 1990 to 2005, despite the US's rapidly declining share of
global GDP.
Chart 10: Capital-Flows-at-Risks in emerging market economies are growing again
Capital Flows as a % of GDP
2
Gross inflows
0
s
-2
Gross
outflow
-4
Average Capital Flows-at-Risk
Contribution of pull factors
-6
Contribution of push factors
Total Capital Flows-at-Risk
-8
1996 1999 2002 2005 2008 2011 2014 2017
Sources: IMF and Bank staff calculations.
are proxied by the Bank of England's global financial conditions
Notes: See chart 7 for notes. Push factors index.
15
Ilzetzki, Ethan, Carmen M. Reinhart, and Kenneth S. Rogoff (2019), Exchange Arrangements Entering the 21st Century: Which
Anchor Will Hold? Quarterly Journal of Economics 134 (2): 599-646.
When the Fed responds to domestic developments (such as a loosening in fiscal policy) global financial
This was the case during both the 2013 'taper tantrum' and over the
conditions and activity react strongly.
past year, as Fed communications significantly shifted expectations for US monetary policy. During both
periods, Capital Flows-at-Risk in EMEs spiked (Chart 10).
Financial (in)stability in advanced economies has also influenced the sustainability of capital flows to EMEs.
During the 2008 global financial crisis, severely undercapitalised and liquidity-constrained banks in advanced
economies severely contracted lending to emerging markets, global risk appetite deteriorated, investors
everywhere retreated out of EMEs into 'safe haven' economies, and
Capital Flows-at-Risk spiked sharply.
Similar channels operated again three years later during the 2011 euro crisis (Chart 10).
In total, push factors from AEs have weighed more heavily over the past decade, which has offset some of the
improvement in 'pull factors',
and shifted the distribution of capital flows back to the left (Chart 11). Keeping
one's own house in order is necessary but not sufficient for sustainable capital flows in the new world
order.16
Chart 11: Push shocks have been increasing Capital Flows-at-Risk
Probabilty density
Negative push shock Post-crisis distribution
2008-2018
0.12
0.10
0.08
0.06
0.04
B
A
0.02
0.00
-8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18
Capital flows as a % of GDP
Sources: IMF and Bank of England staff calculations.
Notes: Notes: This chart shows conditional distributions of capital flows to EMEs post-the 2008 crisis (green), and
conditioning on a one standard deviation negative "push shock"
(red), as proxied by our global financial conditions
index. See chart 5 and annex for further details.
16
Some recent papers have proposed that the existence of a Global Financial Cycle has transformed the well-known international
finance trilemma into a 'dilemma', according to which independent monetary policies are possible if and only if the capital
account is
managed, directly or indirectly (see Rey, H (2013), Dilemma not trilemma: the global financial cycle and monetary policy independence,
in Global dimensions of unconventional monetary policy, proceedings of the Federal Reserve Bank of Kansas City Jackson Hole
symposium, 2013, pp 285-333). Other papers suggest the trilemma is still alive, but the process of trade and financial globalisation has
worsened the trade-offs that domestic central banks face, raising the marginal value of macroprudential tools (see Obstfeld, M (2015),
Trilemmas and Tradeoffs: Living with Financial Globalization," Central Banking, Analysis, and Economic Policies Book Series, in:
Claudio Raddatz & Diego Saravia & Jaume Ventura (ed.), Global Liquidity, Spillovers to Emerging Markets and Policy Responses,
edition 1, volume 20, chapter 2, pages 013-078 Central Bank of Chile).
Pipes
This underscores the importance of the third driver of Capital Flows-at-Risk, the Pipes, or the structure of the
global financial system itself.
Since the crisis, "the pipes" have changed Capital
Flows-at-Risk in at least three ways.
First, over the past decade G20 reforms have made the core safer, simpler and fairer, which has reduced
Capital Flows-at-Risk.
Large global banks' common
equity requirements and buffers are ten times higher than the pre-crisis
standard. In keeping with new global liquidity standards, banks have changed their funding models and their
- -
liquid assets relative to their liabilities that can readily run are tenfold higher now than before the crisis.
Regulation has also made banks less complex and more focused. Trading assets have been cut in half, and
interbank lending is down by one-third.
Second, the growth in assets under management, from around $50 trillion a decade ago to over $80 trillion
today, is bringing welcome diversity to the financial system, but is also increasing the risks of sudden stops
and sharp capital reversals.
Chart 12: Structure of external liabilities for emerging market economies
Sources: IMF, EPFR and Bank of England calculations
For EMEs, market-based finance has accounted for all the increase in foreign lending since the crisis, as bank
lending has declined and FDI has stayed fairly constant (Chart 12).
Within market-based finance, investment funds are growing, accounting for the bulk of the growth in asset
management over the last decade.
In parallel, investment fund flows to EMEs now account for around one third of total portfolio flows, compared
to around one tenth pre-crisis.
These flows are particularly flighty (Chart 13), reflecting the fact that more than $30 trillion of global assets are
held in investment funds that promise daily liquidity to investors despite investing in potentially illiquid
underlying assets, such as EME debt.17 We have recently seen analogous situations in the UK within some
niche managers and smaller markets, such as open-ended property funds investing in commercial real
estate.18 The complications would be much greater if a major asset class like EME debt were to freeze up.
This structural mismatch means that these funds can behave particularly pro-cyclically. Bank of England work
finds that redemptions by EME bond funds (those with larger structural mismatches) in response to price falls
are five times those for EME equity funds (those with less structural mismatch). In turn, EME equity funds are
twice as responsive as AE equity funds.
While the shift to market-based finance has increased global capital flows to EMEs, it also amplifies spikes in
Capital Flows-at-Risk. Moreover, market-based finance flows are particularly sensitive to push shocks,
especially in extreme scenarios (Chart 13). The recent global growth in assets under management has not
yet been fully tested in an extreme scenario, such as a global downturn.
The sensitivity of Capital Flow-at-Risk to push factors, by source of capital flow
Chart 13:
of which: investment
FDI Banking Market-based finance funds
0
-1
-2
-3
-4
Median 5th percentile
-5
Capital Flows-at-Risk as a % of GDP
Sources: IMF, EPFR, Bank calculations.
Notes: Chart shows the sensitivity of different capital flows to a negative "push" shock. Coefficients are standardised by
each component's share of
total flows e.g. the red MBF bar shows how total Capital Flows-at-Risk would respond to a
one standard deviation tightening in global financial conditions if all capital flows were accounted for by MBF.
17
are based on the FSB's measure of 'collective investment vehicles with features that make them susceptible to runs', see
Estimates
FSB Global Monitoring Report on Non-Bank Financial Intermediation 2018.
18
The initial version of the speech mistakenly referred to Real Estate Investment Trusts here, instead of open-ended funds.
The third aspect of the pipes is the global financial safety net (GFSN). Developments in this regard have
arguably further increased Capital Flows-at-Risk. The GFSN has become more fragmented over the past two
- -
decades and its core IMF resources has shrunk relative to the size of the global financial system
(Chart 14). As a result, individual countries have chosen to self-insure at high cost to both themselves and
the rest of the world.
nominal resources have more than tripled over the
While the IMF's past decade, they still only represent
around 1% of global gross external liabilities and have been on a downward trend from 2.5% in 1980. Other
multilateral arrangements, such as Regional Financing Arrangements (RFAs) and swap lines, are only partial
substitutes. RFAs are largely untested and swap lines may only be used in very specific situations between
specific countries.
There is no evidence the formal GFSN deters countries from holding reserves.19 The extra reserves that
EMEs have accumulated over the past two decades have reduced the sensitivity of Capital Flows-at-Risk to
Push factors by almost 50%. But this extra insurance has come at a domestic high cost, both to finance and
because reserves can crowd out domestic investment.20 And it has global externalities, with the vast
accumulation of safe assets distorting yields, building global imbalances and increasing the risks of a global
liquidity trap.21
Chart 14: Components of the global financial safety net as a per cent of global external liabilities
12 3
Per cent of global Per cent of global
external liabilities external liabilities
IMF Permanent (rhs) IMF Temporary (rhs)
10
RFAs (rhs) FX Reserves (lhs)
8 2
6
4 1
2
0 0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Sources: IMF, central bank websites, RFAs, Lane Milessi-Ferretti (2007) External Wealth of Nations dataset and
Bank calculations.
Notes: FX reserves exclude gold.
19
See Scheubel, B, L Stracca and C Tille (2019), Taming the global financial cycle: What role for the global financial safety net?,
Journal of International Money and Finance 94: 160-182.
20
To limit the impact of FX reserve accumulation on the domestic money supply, most central banks sterilise their intervention through
the issuance of bonds. The fiscal cost of FX reserve accumulation can be calculated as the difference between the interest paid on the
sterilisation instrument and the interest received on FX reserve assets, which are typically low-yielding, low-risk foreign government
bonds. The IMF estimated this wedge to be around 200 bps on average. It can crowd out domestic investment as central bank
sterilisation bonds compete for domestic savings.
21
- which Ben Bernanke christened a 'savings glut' -
The increased demand for safe assets driven by this desire for safety helped drive
down the equilibrium interest rate, the interest rate central banks must deliver in order to balance demand with supply and so achieve
stable inflation.
England's Capital
Augmenting the Bank of Flows-at-Risk framework with the major structural changes in the
global financial system materially changes the Bank's assessment of the quantum of Capital
Flows-at-Risk
when there are push shocks.
Chart 15: Major structural changes are increasing the sensitivity of Capital Flows-at-Risk to push shocks
2030 excluding growth in 2030 including growth in
EME external balance EME external balance
2006 2018 sheets sheets
-1
-2
Impact of the increasing role of investment funds
-3
Impact of the shift to market-based finance
Impact of higher share of FX-denominated debt in EMs
Pre-crisis
-4
Total
Capital Flows-at-Risk as a % of GDP
Sources: IMF, EPFR, IIF, Bank calculations.
Notes: This chart shows estimates and projections for the sensitivity of Capital Flows-at-Risk to negative push shocks at
different points in time. The chart is based on separate panel quantile regressions for FDI, banking, market-based finance
and investment fund flows. We use the global FCI (push), country-specific FCIs (pull), and the share of NFC debt
denominated in foreign currency as regressors. The third bar combines regression results with projections for the
composition of flows and the role of FX-denominated debt in 2030, as described below and in footnote 21. The fourth bar
into account projected growth in EM's external balance
also takes sheets as described below and in footnote 21.
In particular, we estimate that the growing shares of FX-denominated debt, market-based intermediation and,
within that, the increasing role of investment funds, have increased the sensitivity of Capital Flows-at-Risk to
-
push factors by 50% since the crisis (second bar, Chart 15) largely using up the self-insurance purchased
by EMEs.
Left unattended, these vulnerabilities are likely to grow.
If history serves as a guide to the evolution of EME balance sheets, EMEs' external liabilities
could double as
a share of GDP by 2030: market-based finance could then account for half of external liabilities, up from one-
third today. And if investment funds keep growing as they have over the past few years they could represent
22
finance flows to EMEs in a decade's time.
40% of market-based
22
There is a systematic cross-country relationship between the size and composition of external balance sheets with levels of incomes per
capita. This has been combined with current forecasts (and for investment funds recent trends) to generate scenarios for the size and
In early stages of development a country's
composition of EM balance sheets in 2030. cross-border finance tends to reflect trade finance
provided by banks. As global value chains develop FDI becomes more important. Finally, market-based finance increases as financial
These flows will benefit EMEs in good times, but if domestic institutional frameworks do not evolve in parallel,
they could also be major sources of instability. By 2030, the sensitivity of Capital Flows-at-Risk to push factors
could triple (fourth bar, Chart 15).
This would fully cancel out the positive impact of domestic reforms in EMEs over the past two decades: the
shift left in the distribution when there is a push shock (grey distribution, Chart 16) is likely to be at least as
great as the shift right that we have seen over the past two decades because of improvements in pull factors.
While t