The Study on the Procyclicality of International Capital Flows

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The purpose of this study is to analyze the pro-cyclical effect of international capital flows on the real economy and to propose the institutional and policy reforms that the former counter-cyclically act on the latter. Although the idea of the pro-cyclicality appears quite frequently in recent studies about international capital movement, there seems to be no established theory to explain about its pro-cyclical mechanism and counter-cyclical policy proposal. The results of this study are summarized in the following points. (1) Our concern is to examine the theoretical hypotheses and experimental studies about the Lucas paradox (1990) of "why capital doesn't flow from rich to poor countries". These considerations make it clear that the answering of this paradox gives the theoretical foundation on our study. (2) We introduce two new approaches to capital flows which have been often neglected in standard economics : the asymmetrical information between lenders and borrowers and the problem of the currency denomination of foreign debt. The former is the over-borrowing syndrome model by R. McKinnon and the latter is the original sin hypothesis by B. Eichengreen. These two approaches are important to our discussion of a future international financial system for East Asian countries. (3) We are concerned with the four stylized facts which Kaminsky, Reinhart and Vegh (2004) found regarding the pro-cyclical interaction between capital flows, fiscal policy, and monetary policy. We apply their main findings to East Asian countries and consider the causes of this pro-cyclical interaction based on the above two new approaches. (4) We extend our consideration to the sustainability of global current account imbalances which are indispensable for this study. Our study supports the result of the simulations by M. Obstfeld and K. Rogoff (2005), who conclude that the real effective exchange rate of the US dollar should depreciate by 33.0 percent.