Unconventional monetary policy and international equity capital flows to emerging markets

• Published date: 01 March 2022
• Author: Christoforos K. Andreou,Nebojsa Dimic,Vanja Piljak,Andreas Savvides
• Date: 01 March 2022
• DOI: http://doi.org/10.1111/eufm.12312

Eur Financ Manag. 2022;28:482–509.482

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wileyonlinelibrary.com/journal/eufm

DOI: 10.1111/eufm.12312

ORIGINAL ARTICLE

Unconventional monetary policy and

international equity capital flows to emerging

markets

Christoforos K. Andreou

1,2

|Nebojsa Dimic

3

|Vanja Piljak

3

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Andreas Savvides

1

1

Department of Commerce, Finance and

Shipping, Cyprus University of

Technology, Limassol, Cyprus

2

Department of Banking and Finance,

Southampton Business School,

University of Southampton

3

School of Accounting and Finance,

University of Vaasa, Vaasa, Finland

Correspondence

Vanja Piljak, School of Accounting and

Finance, University of Vaasa, P.O.

Box 700, FI‐65101, Vaasa, Finland.

Email: vanja.piljak@uva.fi

Abstract

This paper examines the relationship between mone-

tary policies pursued by three major central banks

(U.S. Federal Reserve, European Central Bank and

Bank of Japan) and net equity capital flows to emer-

ging markets (EMs) by global investment funds. We

focus on two aspects of central bank policy: The growth

of central bank assets and the surprise element of asset

growth. We find, first, positive, economically large and

statistically significant spillovers from the U.S. Federal

Reserve asset growth to EM equity inflows following

the adoption of unconventional monetary policies.

Second, U.S. Federal Reserve and (to a lesser extent)

European Central Bank asset growth surprises are ne-

gatively related to EM capital flows.

KEYWORDS

emerging markets, international capital flows, unconventional

monetary policy

JEL CLASSIFICATION

E44, F30, G15

EUROPEAN

FINANCIAL MANAGEMENT

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

© 2021 The Authors. European Financial Management published by John Wiley & Sons Ltd.

We would like to thank the Editor (John Doukas), an anonymous referee, Luis Ceballos, and conference participants of

the Southern Finance Association for very helpful comments and suggestions on previous versions of the paper. Vanja

Piljak is thankful for financial support from the OP Group Research Foundation (grant 20180061), Evald and Hilda

Nissi Foundation and the Foundation for the Advancement of Finnish Securities Markets.

1|INTRODUCTION

This study investigates the effects of unconventional monetary policy (UMP) by the major

central banks on international capital flows. In particular, it focuses on the response of net

equity flows by global investment funds to emerging markets (EMs) to the monetary policies

undertaken by the Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of

Japan (BoJ). Motivation for this study comes from the fact that emerging economies have taken

steps to liberalize their capital account during the past two decades and have become more fully

integrated into international financial markets and, thus, able to attract increasing amounts of

private international capital (Wang & Shih, 2013; Hillier & Loncan, 2019; Kiviaho et al., 2014).

Since the onset of the global financial crisis in 2008, there has been a surge in capital flows to

EMs (see e.g., Ghosh et al., 2014,2017; Li et al., 2018). In the aftermath of the crisis, the level of

policy interest rates reached the zero lower bound (ZLB) in developed markets and forced

central banks to resort to UMP, which, in turn, affected the dynamics of international capital

flows into emerging economies (Ahmed & Zlate, 2014; Chari et al., 2020).

1

This extraordinary

environment of ZLB on interest rates elicited increased interest in examining the determinants

and consequences of these capital flows, including the international spillover effects of UMP.

The existing literature on the determinants of capital flows to EMs distinguishes be-

tween two groups of factors, namely, global (push) and local (pull) factors. Pull factors are

country‐specific variables such as macroeconomic fundamentals and policy‐related char-

acteristics. Push factors are related to general global conditions that capture the economic

climate for investment in emerging economies and are generally outside the control of these

economies (e.g., global liquidity, global risk, etc.).

2

Besides push and pull factors, some

studies include contagion as an additional set of variables that determine international

capital flows (e.g., Forbes & Warnock, 2012;Lietal.,2018). In particular, Forbes and

Warnock (2012) identify three variables that capture contagion effects: Trade linkages,

financial linkages and geographic proximity.

One important theme of the recent literature is that a key determinant of capital flows to

EMs is a ‘global financial cycle’, described as co‐movements in gross capital flows, credit

conditions and asset prices across countries (see, Anaya et al., 2017; Rey, 2015). Furthermore,

the main driver of the ‘global financial cycle’is U.S. monetary policy. There has been a lot of

discussion in the literature about the effect of UMP on global capital flows. The main argument

put forward is that by boosting global liquidity, UMP undertaken by the main central banks in

the wake of the global financial crisis (GFC), has spilled over into capital flows, especially to

EMs that have offered higher returns to global investors. On the contrary, following the an-

nouncement by the Fed of its intention to reduce the size of its balance sheet (assets) in 2013

(the ‘taper tantrum’), it is claimed that the flow of equity capital to EMs by the private financial

sector declined. The claimed link between UMP and equity capital flows to EMs has received

substantial attention in the financial press (see e.g., Financial Times: Wheatley & Kynge, 2016;

Wheatley, 2021)

3

and the recent academic literature (Chari et al., 2020; Dahlhaus &

Vasishtha, 2020). The increase in global liquidity resulting from UMP by the major central

1

For a more comprehensive discussion on UMP in the global low‐interest‐rate environment, see Wu and Xia (2016) and Wu and Zhang (2019).

2

It is not our intention to review push/pull factors here; a comprehensive overview is provided in Ghosh et al. (2014,2017) and Li et al. (2018).

3

These are amongst a plethora of articles in the global financial press on this issue. The latter article points out that spillovers into EM capital flows experienced

in the earlier episodes of unconventional monetary policy, following the global financial crisis, are being repeated during the current cycle of central bank asset

expansion, following the outbreak of the Covid global pandemic.

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