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Staff Working Paper No. 884 How Does International Capital Flow? Michael Kumhof, Phurichai Rungcharoenkitkul and Andrej Sokol

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Staff Working Paper No. 884 How Does International Capital Flow? Michael Kumhof, Phurichai Rungcharoenkitkul and Andrej Sokol CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF PRACTICE 2007 CODE OF 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PRACTICE 2007 CODE OF PRACTICE 2007 Staff Working Paper No. 884 How does international capital flow? Michael Kumhof, Phurichai Rungcharoenkitkul and Andrej Sokol November 2020 This is an updated version of the Staff Working Paper originally published on 21 August 2020 Staff Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the Bank of England or to state Bank of England policy. This paper should therefore not be reported as representing the views of the Bank of England or members of the Monetary Policy Committee, Financial Policy Committee or Prudential Regulation Committee. Staff Working Paper No. 884 How does international capital flow? Michael Kumhof,(1) Phurichai Rungcharoenkitkul(2) and Andrej Sokol(3) Abstract Understanding gross capital flows is increasingly viewed as crucial for both macroeconomic and financial stability policies, but theory is lagging behind many key policy debates. We fill this gap by developing a two-country DSGE model that tracks domestic and cross-border gross positions between banks and households, with explicit settlement of all transactions through banks. We formalise the conceptual distinction between cross-border saving and financing, which often move in opposite directions in response to shocks. This matters for at least four policy debates. First, current accounts are poor indicators of financial vulnerability, because in a crisis, creditors stop financing debt rather than current accounts, and because following a crisis, current accounts are not the primary channel through which balance sheets adjust. Second, we reinterpret the global saving glut hypothesis by arguing that US households do not finance current account deficits with foreigners’ physical saving, but with digital purchasing power, created by banks that are more likely to be domestic than foreign. Third, Triffin’s current account dilemma is not in fact a dilemma, because the creation of additional US dollars requires dollar credit creation by US and non-US banks rather than US current account deficits. Finally, we demonstrate that the observed high correlation of gross capital inflows and outflows is overwhelmingly an automatic consequence of double entry bookkeeping, rather than the result of two separate sets of economic decisions. Key words: Bank lending, money creation, money demand, uncovered interest parity, exchange rate determination, international capital flows, gross capital flows. JEL classification: E44, E51, F41, F44. (1) Bank of England, CEPR and Centre for Macroeconomics. Email: [email protected] (2) Bank for International Settlements. Email: [email protected] (3) European Central Bank, Bank of England and Centre for Macroeconomics. Email: [email protected] The views expressed in this paper are those of the authors, and not necessarily those of the Bank of England, the Bank for International Settlements, the European Central Bank, or their policy committees. The authors thank Stefan Avdjiev, Jaromir Benes, Claudio Borio, Piti Disyatat, and seminar participants at the Bank of England for helpful comments. The Bank’s working paper series can be found at www.bankofengland.co.uk/working-paper/staff-working-papers Bank of England, Threadneedle Street, London, EC2R 8AH Email [email protected] © Bank of England 2020 ISSN 1749-9135 (on-line) 1.
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