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In his 1998 article, Eichengreen discusses interest rates and capital flows between developing and developed countries. The first theory he outline suggests that the price and availability of foreign finance is highly dependent on the financial conditions in capital-importing countries. The second theory he discusses hypothesizes that the price and availability of foreign finance is dependent on external financial conditions (e.g. interest rates in U.S.). He argues then argues that linear regression analysis reveals no positive correlation between U.S. treasury rates and demand for emerging-market bonds. His analysis reveals that U.S. interest rates affect investors’ demand for LDC bonds, such that high US interest rates discourage the flow of capital into these markets and low interest rates promote investors to acquire debt in these markets. The key revelation he makes in this study is identifying the importance of fixed and floating rate effects on capital flow, which previous analysis has largely neglected.

Vincent Kim

This paper enriches Chapter 11 of the Todaro and Smith text, especially the section “Problems of Plan Implementation and Plan Failure.” The text mentions that LDCs often struggle to implement successful growth policies because of external economic disturbances, and this paper explains those disturbances in quantitative terms. While Eichengreen and Mody mention the current qualitative explanations of how interest rates in the developed countries in the global North affect capital flows to the less developed countries in the global South, their main contribution is their regression analysis. Interestingly, they find that different types of loans, whether they are fixed-rate or floating-rate loans, should be treated separately in studies.

Furthermore, in a sense, this paper tries to help solve the problem of insufficient and unreliable data which can make development policies inaccurate and flawed. If countries could understand more quantitatively how global interest rates affect capital inflow in LDCs, countries and institutions such as the World Bank and the International Monetary Fund could take part in better development plans that achieve their desired outcomes of injecting capital into LDCs more precisely. Under current conditions, the lack of information and unanticipated economic disturbances discourage LDCs from enacting costly, long-term development policies, so these issues could be a major areas of interest in trying to solve development problems.

Julia Murray

This paper helps to explain why previous econometric evidence has not supported the hypothesis that external conditions, mainly interest rates in developed countries, impact international capital flows in developing countries. External interest rates do in fact have an impact on capital flows in addition to internal macroeconomic stability, which shows the importance of taking a comprehensive view of developing economies, rather than only looking at one aspect of an issue. I also thought this paper demonstrates the importance of random experiments that Esther Duflo discussed in the video clip we watched in class. Part of the reason that it is so hard to use regressions to depict the impact of a certain variable, ie. interest rates in the U.S., on another variable is that there is no "control" group in the real world. Since we have nothing to compare these time periods to, we can only try to isolate individual effects with a regression, which will obviously not be as reliable as a controlled experiment. However, this issue would be difficult to test as a controlled experiment on a microeconomic level because it is a macro issue. Therefore, the best we can do is try to specify a regression as accurately as possible, such as the regression performed by Eichengreen.

Peter Partee

Peter Partee
Economics 280 – Development Economics
Professor Casey
Blog Post 10-24

“Interest Rates in the North & Capital Flows to the South: Is There a Missing Link?”

Eichengreen and Mody begin by describing a debate amongst economists about how development is best facilitated by public policy. On one side, reside those who assert that increase privatization at the firm level and country-wide economic liberalization will lead to increased growth. Whereas on the other side of the argument, economists and policy makers contend that monetary policy, specifically manipulation of interest rates can attract investors searching for yield when countries like the United States have particularly low rates.

The authors focus on the latter of these approaches by responding to previous econometric studies, in which regression analysis failed to appropriately explain the link between U.S. treasury rates and emerging market spreads. Ordinary least squares regression techniques are “misleading,” because United States treasury rates affect the nature and volume of international lending. In contrast to previous research, the authors find evidence to suggest that changes in Unites States interest rates significantly affect emerging market spreads. This is perhaps, the most important aspect of this paper to recognize: that it is a reconciliation of theory and previous research.

A point of contention for the authors is that the developing country wishing to receive capital inflows needs to undergo economic reform in order to become a more attractive, safer, investment for international capital, as well as experience a decrease in interest rates in developed countries. Rather the decrease in interest rates in “industrial countries” is the most important factor in international inflows to developing countries.

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