Financial Globalization and Macroeconomic Policy

Abstract

This thesis comprises three self-contained essays that contribute to the debates on macroeconomic policy configuration in the context of financial globalization. Following the introductory chapter, which provides an overview of the implications of financial globalization for macroeconomic policymaking, the first essay (Chapter 2) examines the relationship between foreign reserve accumulation and domestic private investment. Reserve accumulation is one of the preferred strategies to protect against susceptibility to financial crises. However, the implications of this policy choice for domestic investment remains a debatable issue. On the one hand, sterilization operations implemented as part of reserve accumulation strategy could crowd out financing for domestic investment. On the other hand, maintaining a healthy international reserve position has the potential to promote domestic investment by reducing the cost of foreign borrowing through improving international creditworthiness. The econometric analysis is based on a newly-constructed panel data set covering 58 countries over the period 2000-2014. The results provide support for the policy of relying on reserve accumulation for a cushion against external shock: notwithstanding a mild negative effect in the short run, maintaining a healthy reserve position seems to promote investment in the long run. The third chapter examines the implications of exchange rate regime choice and capital flow management (CFM) for real exchange rate (RER) misalignment using panel dataset for 60 developing countries over the period 1980 - 2014. The analysis is based on an alternative index of RER that is more consistent with the theoretical concept of RER than the commonly used IMF index. RER misalignment is estimated by paying due attention to country-specific underlying factors. The results suggest that the exchange rate regime and capital account policy are significantly related to the degree of persistence and the magnitude of RER misalignment. The fourth chapter examines the effectiveness of capital flow management through a case study on Indonesia, a country that figures prominently in the debate on the sequencing of liberalization reforms as a unique case of liberalizing the capital account well before trade liberalization and domestic financial sector reforms. The analysis covers the Indonesian experience during the period 2000 - 2019. The methodology involves constructing a new capital flow management policy restrictiveness index (CFMIX) and examining impulse responses of these flows to CFMIX adjustments through structural vector auto-regression (SVAR) estimation. The index shows that the Indonesian CFM policy stance has been more accommodative of capital inflows and restrictive on outflows over time. The results indicate that capital inflows in the form of portfolio investment are significantly responsive to CFM measures. However, there is no evidence of a significant impact of CFM policy on capital outflows. The last chapter of the thesis provides an overall conclusion and identifies potential research areas for further explorations. Show more