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The Impact of Capital Inflows on Asset Prices in Emerging Asian Economies: Is Too Much Money Chasing Too Little Good?

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Abstract

In recent years, emerging Asian economies have experienced (i) large capital inflows, especially a surge in portfolio inflows, and (ii) an appreciation of asset prices such as stocks, land, and nominal and real exchange rates. We empirically investigate the effects of capital inflows on asset prices by employing a panel VAR model. The empirical results suggest that capital inflows indeed have contributed to asset price appreciation in the region, although capital inflow shocks explain a relatively small part of asset price fluctuations.

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Notes

  1. Monetary policy reacts to asset prices is highly controversial in general. See Roubini (2006); Filardo (2004); Borio and Lowe (2002); Bordo and Jeanne (2002); Cecchetti et al. (2002); and White (2006) for active monetary policy role in considering asset prices in its objectives. See also Mishkin (2001), Schwartz (2002), Bernanke and Gertler (1999, 2001), Gilchrist and Leahy (2002), and Goodfriend (2003) for opponents of active monetary policy.

  2. Refer to Tirole (1985).

  3. For example, Kim et al. (2004); Montiel (1996); Agenor and Hoffmaister (1998); Corbo and Hernandez (1996); and Jansen (2003).

  4. Corsetti et al. (1999) points out that the causes of the crisis lie on financial over-lending, banking problems, and the composition, maturity, and size of capital inflows in Asia. Mishkin (1999) also asserts that the crisis started with financial liberalization that resulted in a lending boom that was fed by capital inflows, and bank lending expanded so rapidly that excessive risk-taking prevailed. Excessive bank lending to the real estate sector has also been noted. Sachs and Woo (2000) point out that too much money was poured into speculative real estate projects. Krugman (1998) also states that the problem began with financial institutions whose liabilities were perceived as having an implicit government guarantee, but were essentially unregulated and therefore subject to a severe moral hazard problem. The excessive risk lending of these institutions created increases in price, not of goods, but of financial assets.

  5. Gross capital inflows are defined as nonresident investment of FDI, portfolio investment and other investments to emerging Asian economies.

  6. Gross capital outflows refer to the total resident investment abroad including FDI, portfolio, and other investments.

  7. Specifically, we generated the standard error bands based on a Bayesian method, as described in RATS Manual.

  8. Enough data series are not available for other countries.

  9. Some variables, such as capital inflows, are not available in monthly frequency.

  10. A linear trend in GDP is assumed. Assuming different types of trends such as the quadratic trend do not affect the results much.

  11. Although the current studies are using quarterly data, with which the assumption is more restrictive than some studies such as Kim (1999), Kim and Roubini (2000) using monthly data, Sims and Zha (2006) and Christiano et al. (1999) showed that the assumption is also applicable to quarterly data.

  12. In Kim et al. (2004), capital flows are assumed to be contemporaneously exogenous to real output, which is different from the assumption made in this paper. Kim et al. (2004) investigated the effects of capital flows shocks that are not related to current account movements. On the other hand, this paper tries to examine the effect of capital inflows after controlling determinants of capital inflows. The difference in the identifying assumption of Kim et al. (2004) and this paper originates from the different issues being discussed.

  13. Using daily stock price data, the stock price at the last date during the quarter is constructed.

  14. Refer to Christiano et al. (1999).

  15. However, the estimation period does not include the most recent dates when asset price appreciation accelerated and serious concerns about capital flows emerged. If a more recent period were included, the role of capital flow shocks might increase.

  16. In this model, we still assume that capital inflows are contemporaneously exogenous to stock price. As previously explained, stock price data is end-of-period data but capital inflows data is an accumulation over each period. Therefore, it does not make much sense to assume that end-of-period stock price is contemporaneously exogenous to capital inflows over the seven-year period being examined in this study.

  17. Same as in Fig. 14, the name of the type of shocks (either capital inflows shocks or portfolio inflows shocks), the name of the responding variable (either stock price or land price) and the structure of the model (“exog” indicates the first type of model while “endo” indicates the second type of model) are defined at the top of each graph.

  18. The exception is the land price responses in the second model. In the second model, capital flows are not allowed to affect land price contemporaneously, so that the impact effect is zero and responses over time are small. However, the point estimate still shows the increase in the land price over time, and the increase is different from zero with 84% probability in the case of capital flows shocks. In addition, this assumption is less reasonable than the assumption of the basic model as it is not very likely that capital inflows to land market in emerging Asia for momentum trading as discussed in Section 3.2.

  19. See Kim et al. (2004) that capital flow shocks affect macroeconomic condition significantly in the 1990s.

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Authors and Affiliations

  1. Department of Economics, Seoul National University, San 56-1, Sillim-Dong, Gwanak-Gu, Seoul, 151-746, Korea

    Soyoung Kim

  2. Asian Development Bank Institute, Kasumigaseki BL 8F, 3-25 Kasumigaseki, Chiyoda-ku, Tokyo, 100-6008, Japan

    Doo Yong Yang

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  1. Soyoung Kim
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  2. Doo Yong Yang
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Correspondence to Soyoung Kim.

Additional information

We thank Cindy Houser, Jong-Wha Lee, and Lei Lei Song for various suggestions, editing, and data construction.

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Kim, S., Yang, D.Y. The Impact of Capital Inflows on Asset Prices in Emerging Asian Economies: Is Too Much Money Chasing Too Little Good?. Open Econ Rev 22, 293–315 (2011). https://doi.org/10.1007/s11079-009-9124-x

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