<!-- Start of picture text --> URY<br>Currency Cyclicality Index = 0.05 + 0.41*Capital Flow Cyclicality<br>(1.35) (2.91) Monetary Policy Cycl. = -0.31 + 0.51*Capital Flow Cycl.<br>KOR IDN (8.77) (4.37)<br>MEX CRI<br>URY PER<br>TURUKR CHL<br>SWEARG MYS THAPHL ISLMEXNZL PRT ISR GRC IND TURBGR<br>CAN NORMLT DNKITAGBR FINCZE ESPPRTMARAUSCHLHRVISRSVKPERZAFGRCBRA COL INDHUN FRACYPNOR AUTITAIRL FINCZE JPNESP MAR KORTHAZAFPHLBRA NZL<br>BEL FRACYP HKGDEUAUTIRLLUXCHE JPNNLD LVAUSA ESTBGRCRI BEL DEUDNKGBR SWE MYS COLUSA<br>CAN CHE NLDAUS<br>-.4 -.2 0 .2 .4 .6 -.4 -.2 0 .2 .4 .6<br>Capital Flow Cyclicality Capital Flow Cyclicality<br>1<br>.4<br>.2<br>.5<br>0<br>-.2<br>0<br>Currency Cyclicality Index<br>Monetary Policy Proyclicality -.4<br>-.6<br>-.5<br><!-- End of picture text --> Note: Procyclicality of capital flows is calculated as the correlation between the cyclical components of quarterly GDP and private net capital inflow. The currency cyclicality index is computed as the coefficient of correlation between the cyclical components of GDP and exchange rates, where the cyclical components are deviations from the trends for quarterly data for 62 countries from 1975, q1 to 2013, q1. Cyclicality of monetary policy is calculated as the correlation between the cyclical components of GDP and short-term interest rates; monetary policy stance is considered to be procyclical if the interest rates are high during the periods of low economic growth. Data on net foreign currency position is from Benetrix, Lane, and Shambaugh (2014), and refers to 1995.

In recent years however emerging economies appear to be making a transition from procyclical monetary policy to countercyclical monetary policy. The evidence points at the consistently improved net foreign exchange position of emerging economies--countries have reduced the mismatch in their external balance sheets (Figure 2), due to improved current account positions, larger foreign reserves (figure 3), shift in the composition of capital flows to equity from debt; and the success in developing local currency debt markets. Aizenmann et al (2015) particularly emphasize the role of larger reserve holdings of the emerging countries for this shift in the policy orientation of emerging countries.<sup>8</sup> A move to inflation targeting could be another reason for this transition, as noted in McGettigan et al (2013). Evidence therein shows that the countries that have successfully transitioned to countercyclical monetary policy are the ones which have adopted an inflation targeting framework, possibly reflecting strengthened monetary institutions allowing them to pursue independent monetary policy. Cordella and Gupta (2015) corroborate these findings, and in addition note that in recent years, monetary policy in emerging market economies is influenced less by exchange rate movements, and more by economic growth.

8 See Lane and Shambaugh (2010) for trends in the foreign currency position of emerging countries. Aizenman et al (2015) document the increase in the international reserves held by emerging markets since the early 2000s, attributing it to insure against volatile capital flows, mercantilist motive for specific countries, and possibly even to a regional demonstration effect—a country may gather reserves to keep up with the other countries in the region, termed as the “keeping up with the Joneses” effect.

6