The Pre-Crisis Capital Flow Surge to Emerging Europe: Did Countercyclical Fiscal Policy Make a Difference?

Ruben Atoyan, Dustin Smith and Albert Jaeger

No 2012/222, IMF Working Papers from International Monetary Fund

Abstract: A push-pull-brake model of capital flows is used to study the effects of fiscal policy changes on private capital flows to emerging Europe during 2000-07. In the model, countercyclical fiscal policy has two opposing effects on capital inflows: (i) a conventional absorptionreducing effect, as a tighter fiscal stance acts as a brake on capital flows; and (ii) an unconventional absorption-boosting effect, as a tighter fiscal stance increases investor confidence in the country. The empirical results suggest that push factors (low returns in flow-originating countries), rather than pull factors (high returns in flow-destination countries), drove most of the private capital flows to emerging Europe. And active countercyclical fiscal policy once the fiscal stance is adjusted for the automatic effects on the fiscal position of both internal and external imbalances acted as a brake on capital inflows. However, the empirical results also suggest that, even abstracting from political feasibility and fiscal policy lag considerations, countercyclical fiscal policy alone is unlikely to be an effective policy tool to put an effective brake on sudden capital flow surges.

Keywords: WP; exchange rate; financial crisis; Capital flows; fiscal policy; absorption boom; fiscal policy stance; countercyclical fiscal policy; investment climate; country dummy; Europe country; EU accession process; Capital inflows; Fiscal stance; Output gap; Europe; Global (search for similar items in EconPapers)
Pages: 34
Date: 2012-09-01
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Citations: View citations in EconPapers (13)

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