2009 and the first half of 2013 is estimated to have had the largest impact on capital inflows during this period (Figure 5).<sup>4</sup> Both domestic and global factors appear to be important determinants of capital inflows to developing countries, with global factors (U.S. interest rates, risk and the additional unmodeled influence of quantitative easing) together accounting for about 60 percent of the increase in capital inflows between 2009 and 2013, with the remaining 40 percent explained by domestic factors such as countries’ institutional investor rating, and developing-country growth and growth differentials.

About 13 percent of the total variation in capital flows during this period is picked up by the quantitative easing dummy, suggesting that capital flows were larger in the post-crisis period than would have been expected given the levels of other variables. These effects appear concentrated on earlier rounds of quantitative easing. When the quantitative easing indicator is split into separate episodes corresponding to QE1, 2, and 3, the impact on inflows diminishes between successive episodes. Indeed, when broken out, the QE3 variable is statistically insignificant— implying that by then all of the impact of quantitative easing on capital flows has been accounted for through its effect (if any) on the traditional drivers of capital flows.

# _Implications for capital flows as global conditions normalize_

The preceding analysis confirms previous research suggesting that global economic conditions play a major role in determining capital flows to developing countries.

As conditions in high-income countries improve (that is, as output gaps are closed and growth realigns with underlying potential output), monetary policy can be expected to normalize, and the extraordinary monetary policy measures that have been undertaken will be withdrawn. In this context, capital flows to developing countries should adjust to a new equilibrium. Simulations based on the panel regression results are shown in Table 1.

These simulations are conditioned on the following underlying assumptions:

- Developing and high-income country GDP growth gradually strengthens in line with the projections presented in World Bank (2014).

- QE tapering by the U.S. Federal Reserve spans from January to December 2014, and has a very gradual effect on market conditions. It adds 50 basis points (bp) to U.S. long-term interest rates by the end of 2015 and a cumulative 100bp by the end of 2016. Policy rates in the United States start to increase in 2015Q3, from 0.25 to 2 percent by the end 2016.

- The European Central Bank (ECB), Bank of Japan and Bank of England, start to unwind their own quantitative/qualitative policies in the course of 2015-16, adding 50bp to their long term yields by the end of the forecast horizon, and tighten policy rates later than the U.S. Fed does.

> 4 Estimates of the relative contribution of different factors in Figure 5 were calculated by multiplying the observed changes in short-term policy rates, yield curve, the QE episode dummy, and the risk index between the first half of 2009 and the first half of 2013 by the coefficient estimates obtained from the benchmark model.

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