Inflation targeting and capital flows: A tale of two cycles in developing countries

Olena Ogrokhina and Cesar Rodriguez

Journal of International Money and Finance, 2024, vol. 146, issue C

Abstract: Global factors have traditionally determined capital flows, but domestic policies also matter. Developing countries face the challenge of managing procyclical capital inflows that can destabilize their macroeconomic environment. Inflation targeting can help solve this problem by enhancing the credibility and predictability of monetary policy. In this paper, we explore how inflation targeting affects the cyclical behavior of capital inflows in developing countries. First, we complement the data on international capital flows from the IMF with locational and consolidated banking statistics from the BIS. Second, we address the self-selection associated with inflation targeting by using entropy balancing. We find that inflation targeting reduces the procyclicality of capital inflows in developing countries. Specifically, inflation-targeting countries receive more (less) capital inflows during recessions (booms) than non-targeting countries. Other investment debt from the private sector mainly drives this effect. Our results are robust to various sensitivity checks and alternative specifications and methodologies.

Keywords: Inflation targeting; Capital inflows; Cyclicality; Developing countries (search for similar items in EconPapers)
JEL-codes: F02 F34 F41 G15 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:146:y:2024:i:c:s0261560624001086

DOI: 10.1016/j.jimonfin.2024.103121

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