When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies

Based on a sample of 104 countries, we document four key stylized facts regarding the interaction among capital flows, fiscal policy, and monetary policy. First, net capital inflows are procyclical (i.e., external borrowing increases in good times and falls in bad times) in most Organization for Economic Cooperation and Development (OECD) and developing countries. The procyclicality of net capital inflows is particularly strong for middle-high-income countries (emerging markets). Second, fiscal policy is procyclical (i.e., government spending increases in good times and falls in bad times) for the majority of developing countries. Third, for emerging markets, monetary policy appears to be procyclical (i.e., policy rates are lowered in good times and raised in bad times). Fourth, in developing countries—and particularly for emerging markets—periods of capital inflows are associated with expansionary macroeconomic policies and periods of capital outflows with contractionary macroeconomic policies. In such countries, therefore, when it rains, it does indeed pour.