We investigate the relationship between global financial conditions and the real economy between 2000 and 2017, with a special focus on emerging markets. First, we find gross capital inflows to be strongly related to the provision of credit to the local private non- financial sector. Second, bond emissions by emerging market nationals are associated with lower local lending rates and higher local credit provision, especially following quantitative easing by the Federal Reserve System. Third, we find that periods of large capital inflows coincide with a reallocation of labour to less productive sectors. When comparing our results with previous literature, we find productivity gains through the reallocation of labour to be substantially lower in emerging markets.
Motivated by the recent surge in foreign currency debt issuance by emerging market non-financial firms, we study the dynamic effects of a real interest rate drop on the production decisions of value maximizing firms and of domestic households. Credit constraints that limit the financing possibilities of national households induce firms to engage in carry-trade activities and the profitability of these activities depend on the interest rate differential vis-a-vis the world economy. The economic structure is given by a conventional two-sector open economy model, investment limited to the traded good only. After a large drop in the international interest rate, non-financial firms increase bond emissions on international markets and transform obtained proceedings into domestic household credit. This 'sugar rush' of abundant finance initiates a period of hyperactivity that is characterized by large increases in consumption and investment. Furthermore, the boom in economic activity is accompanied by a reallocation of productive resources from the traded into the non-traded sector of the emerging market economy. By analytically considering the evolution of the capital stock, we highlight the long-run structural consequences of bond financed capital inflows.
Contributing to the debate on the impact of external financial shocks on small open economies, we show that different financial shocks, such as the Federal Funds Rate, bond spreads, and the balance sheet of the Federal Reserve System, affect macroeconomic performance in the short and long-run. We build on the structural implications of a small open economy model with two sectors in order to estimate a structural vector autoregressive model with external variables (VARX). The main findings are: (i) international liquidity leads to lower local lending rates; (ii) capital inflows add to the liquidity on local credit markets; (iii) global financial shocks contribute to the reallocation of economic activity towards the nontraded sector of the economy; (iv) corporate financing decisions add to local liquidity via capital inflows.