Capital flows refer to the movement of money for the purpose of investment, trade or business production, including the flow of capital within corporations in the form of investment capital, capital spending on operations and research and development (R&D).On a larger scale, a government directs capital flows from tax receipts into programs and operations and through trade with other nations and currencies. Individual investors direct savings and investment capital into securities, such as stocks, bonds, and mutual funds.
Categories of capital flow
Asset-class movements are measured as capital flows between:
- bonds, and other financial instruments, while venture capital shifts in regards to investments being placed in startup businesses. Mutual fund flows track the net cash additions or withdrawals from broad classes of funds. Capital-spending budgets are examined at the corporate level to monitor growth plans, while federal budgets follow government spending plans (Gelos, 2011).
Factors that influence on capital flow
Capital flows respond differently to global factors depending on whether a country's monetary authorities intervene in foreign exchange markets to influence the local currency exchange rate, or whether a capital flow pressures result in changes un the exchange rate or interest rate sufficient to disclosure capital flow pressures from being realized in actual flows. In fully floating exchange rate regimes, capital flow pressures would materialize in exchange rate adjustments while in fixed exchange rate regimes, the price adjustment is prevented, and a capital flow is fully realized in response to the same pressure. Recent event studies of international monetary spillovers underscore the importance of this point, with full international capital flow pressures reflected in actual flows, as well as in exchange rate or interest rate changes (Goldberg, 2018).
Exchange market pressure index
Exchange Market Pressure Index (EMP) measures capital flow pressures in units of exchange rate depreciation equivalents, with an increase denoting a capital outflow pressure. For analytical purposes, it is like a “super exchange rate” index that directly accounts for central bank interventions in the foreign exchange market by converting the intervention to a hypothetical exchange rate response calibrated to country-specific asset market conditions. EMO can be used to show the period by global factor over time, also testing for differences between so-called safe haven currencies and emerging markets. The importance of the common global factor changes significantly over time (Goldberg, 2018).
Global Risk Response
Global Risk Response (GRR) index, to empirically categorize the link between global risk factors and changes in international capital flow pressures by country. The index is constructed as the correlation between monthly observations of a measure of global risk sentiment and monthly observations of the GRR. The GRR shows that the status of currencies evolves over time. While currency status has some persistence, the label of “safe haven” for currencies and for countries clearly is not stagnant (Goldberg, 2018).
- Árvai Z. (2005), Account Liberalization, Capital Flow Patterns, and Policy Responses in the EU's New Member States, International Monetary Fund, Washington,
- Gelos G. (2011), International Mutual Funds, Capital Flow Volatility, and Contagion-A Survey, International Monetary Fund, Washington,
- Giordani P. (2014), Capital Flow Deflection, International Monetary Fund
- Goldberg L. (2018), Capital Flow Pressures, International Monetary Fund, Washington
- Rowley C. (2013), Trade and Capital Flow among Asian Economies, Routledge, Oxon.
Author: Katarzyna Adamczyk