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Does domestic economic policy uncertainty transmit capital inflow surges and sudden stop shocks to GDP growth? Evidence in this chapter shows that elevated policy uncertainty prevents GDP growth from rising more due to capital inflow surges shock and accentuates the decline more due to sudden stop shocks. In addition, elevated domestic economic policy uncertainty shock raises the likelihood of sudden stop episodes and reduces the likelihood of capital inflow surges episodes following an unexpected reduction in VIX. Evidence shows that sudden stops as defined using metrics in Forbes and Warnock (2011) are associated with a significant slowdown in economic growth, stock market activity and currency depreciation. In contrast, capital inflow surge episode shocks raise economic growth, appreciate the exchange rate, lower inflation, and the raise stock market. Evidence indicates that VIX a non-domestic factor significantly raise the likelihood of sudden stops episodes while reducing the likelihood of surges episodes. This has implications on how policymakers should deal with capital inflow episodes because global risk is a driver of capital flow volatility but this is outside the control of policymakers and poses policy dilemmas. First, in line with Forbes and Warnock (2011) evidence suggests that policymakers concerned about effects of capital flow volatility should prioritise strengthening the country’s ability to withstand the volatility. Second, this analysis shows policymakers should heed that foreign and domestic investors can be motivated by different factors and react differently to various policy interventions and other shocks.
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- Capital Flow EpisodesCapital flow episodes and Real Economic Costs of Flow Episodes
- Chapter 17
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