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BOK Working Paper No.2020-28, Dynamic Relationship between Foreign Capital Inflow and Inflation: Evidence from Eight Small Open Economies in Asia

Economic Research Institute (82-2-759-5471) 2020.12.10 843

Title: Dynamic Relationship between Foreign Capital Inflow and Inflation: Evidence from Eight Small Open Economies in Asia

Author: Young Jun Choi(BOK), Jong Chill Son(Hankuk University of Foreign Studies)

<Abstract>

This paper investigated the effects of capital inflow by type on domestic inflation for eight small open economies in Asia using panel VAR and data from 2000 to 2018. The estimation results overall indicated that expansionary effects from aggregate demand caused by capital inflow were larger than the exchange rate effect and subsequently, the capital inflow had overall positive (+) effects on inflation. More specifically, first, the capital inflow by foreign equity investments and other investments had positive (+) effects on inflation while foreign bond investments had a limited effect on inflation. This insignificance in capital inflow by bond investment can be attributable to the fact that central banks’ monetary policy holding short-term interest rates and less developed financial markets. Second, the increasing effects of capital inflow by equity and other investments on inflation were more pronounced in non-IT (inflation targeting) countries. Lastly, the effects of capital inflow by other investments in the countries with less developed financial markets had greater positive effects on inflation than in countries with developed financial markets. Meanwhile, there was no clear difference between two country groups for capital inflow by foreign equity investments.

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