« ECON 280 for Tuesday | Main | ECON398 for Tuesday »



Mitchell Brister

This paper discusses the causes for capital flows into developing nations by looking at the effect of US treasury yields. One side of the argument is that the flow of capital is largely determined by internal policy and economic conditions. The other argument is that the flow of capital is determined by the external economic conditions and more specifically to this paper the yields on the US treasury bonds. Traditionally research has only used regressions between the yields on Treasury bonds and the cash flows into developing countries without taking into account volume and composition of the treasury bonds. This paper tries to correct this mistake. They found that the international bond rates do have an effect on the the market for developing countries.

This paper has really made me think back to Professor Reiter’s Globalization and Economic Development class in which we discussed international cash flows and Foreign Direct Investment. While often looked at as a positive way for developing countries to access capital and grow, there is a downside. Local markets and producers in the markets can often be crushed by large international firms coming into a country. On top of this, in the same way that FDI can flood into a country, it can flow out. When a situation like this happens the local economy is crushed. These are just two things that came to mind when reading this paper, and two subjects that I hope to discuss in class.

Jacqueline Carson

Barry Eichengreen and Ashoka Mody's paper "Interest Rates in the North adn Capital Flows to the South: Is there a Missing Link" attacked the discrepancy that existed in finance economics for many years. Qualitatively, evidence has shown that international interest rates and capital flows of investment have a negative relationship. However, empirical regression analysis has not shown the relationship as such. Many ideas have been tossed around for what affects capital flow of investments to developing countries, not the least of which is the internal stability and political structure of the country receiving the flow. What past empirical experiments have left out of their regression analysis is examining both the supply and the demand of the capital flow. By just looking at supply of the capital flow they are eliminating a very important aspect - the actual market demand for bearing the debt that the receiving country bears. The authors argue that by leaving out this large detail, past experimenters yield inaccurate results. By including the demand, the researchers have decreased the disparity between the qualitative and quantitative research. They concluded by stating that international interests and capital flows do have a negative relationship.

This article reminded me a lot of the article that we read about FDIs when Professor Siwal was guest lecturing. That paper also discussed how hard it is to identify what causes FDI. It is interesting because it seems that there are many lay perceptions about FDI (that it is always helpful, the more the better, its causes etc.) but when it is studied empirically, the perceptions do not always hold true. However, what this paper teaches us is that we must always question the status quo and constantly look for new explanations that could shed light on the given issues.

What I keep gathering from most of the papers that we read regarding development is that there is never one exact answer to solve the problem. This is why the study of economic development is frustrating but also why it is so important.

Rachana Ghimire

This paper hoped to bridge the gap between previous studies in linking spreads of U.S. treasure yields to flows into developing countries because previous studies did not look at both the supply and the demand of capital inflows. They argue by leaving out the demand of capital inflows, previous studies’ findings are inaccurate, and they hope to shed more light on the relationship between capital inflow and developing countries. While their main finding was that there is a negative impact of higher U.S. rates on the demand by international investors – especially for fixed-rate issues by Latin American borrowers, they can state it with more confidence by taking both the supply and demand into account. The paper goes more in depth into this, but what I found fascinating was footnote 8, where authors give a specific example of how institutions can affect a country’s economy. They talk about how in Colombia - “exchange controls were abolished; imports were liberalized; labor legislation was reformed; controls over direct foreign investment were relaxed; the financial sector was deregulated; legislation governing ports and operations was modified; the insurance industry was liberalized; and the tax system was modernized.” Other countries followed suit as well including Peru, Venezuela, and Bolivia. Jaqueline pointed out how hard it is to identify what causes foreign direct investment, and whether it actually helps. While the paper also reminded of professor Silwal’s talk, I also thought about the class “institutions and economic performance” that professor Grazjl teaches. In the class, we went into depth about how institutions are the key role to economic growth. While I agree that liberal trade policies, financial development (negative effect), labor Force, infrastructure, rule of Law (transparency) are all things that could influence foreign direct investment, I think they all can fall into some institution. Developing countries often lack these institutions, and while it is harder to change institutions in a country rather than investing more – I think it’s more of a long-term solution rather than a short-term fix.

Rachel Stone

This article lays out the problem in the debate that the role of interest rates in industrialized nations has on the economies of developing countries. These authors concluded that international bond rates do in fact have an effect on the the market for developing countries. This conclusion is reached by analyzing both supply and demand effects and the balance between the two, something the authors say wasn't done in prior research that concluded there was no effect.

Countries must have certain features to attract foreign direct investment to begin with, generally some type of institutional base. If I'm understanding Rachana's comment, she said that building this institutional base is a long-term solution rather than a short-term fix, I would argue that that's what we ultimately are searching for. As we saw in prior papers, countries frequently have short-term economic bursts. The struggle is maintaining this economic development long-term. If FDI by way of institutions seems like a long-term solution, that's potentially where we would want to focus our efforts. However, like Jacqueline said, this is what makes the study of economic development so frustrating. There is no one answer or guaranteed solution. This paper expands prior research and gives insight regarding a potential effect on developing nations, but it also cannot present a single answer to the development problem.

Andrew Head

The authors begin by noting why the debate over capital flows between industrial and developing countries is important--it has "profound implications for advisability of widespread capital account liberalization versus the retention of controls on capital inflows." As opposed to previous studies, Eichengreen and Mody use aggregated data to paint a clearer picture of the effect of U.S. Treasury yields on the availability of financial capital in developing countries. The authors find that higher U.S. Treasury yields dampen international investors' demand for both fixed-rate Latin American debt and floating-rate East Asian debt.
What does all of this mean? That the ability of developing countries to raise debt in the capital markets is not only dependent on internal creditworthiness, but also on external factors determined in the international financial markets that are out of the control of the developing nations trying to issue bonds. I can't help but wonder what will happen over the next year or two as the Federal Reserve starts to raise interest rates--will international investors start sending financial capital to the U.S. over developing nations?

Riley Stout

The Eichengreeen and Mody paper illustrates the relationship between interest rates in industrial countries and capital flows to developing countries. For years, it was assumed that as interest rates in industrial countries increased, such as the United States, capital flows to countries would decrease. However, this article’s empirical evidence displays that this assumption is not necessarily true. It’s interesting to see that for years people assumed that there were not any other major factors to this assumption. I found it interesting that a basic model of economics explained how the empirical evidence didn’t support the negative relationship between interest rates of industrial countries and capital flows to developing countries. The demand for cash flow by borrowers in developing countries was the concept that this assumption failed to take into consideration.

A common theme that has been presented in numerous papers we have read over the term indicates that the people of developing countries do not always accept policies implemented by developed countries. This could be attributed to the fact some people think these policies cause even more hardships in the short term with no guarantee of success in the long term. Cultural difference may also provide differences of opinion on certain policies. The role of women can also play a role where policies are attempting to help women; however, their husbands might prevent them from participating.

Jack Masterson

We have talked a lot in this class about how one of the major challenges developing countries face is a lack of access to capital. Most of our discussions have been at the individual level but the importance is still there at the country level. Lending to a corporation or someone is investing, they expect to earn a return on the money they put up. A lot of the lending and access to capital measures we have discussed previously are still about making money for the person but there is some charitable aspect that makes the decision to lend or not solely financial. I think this article does a good job of looking at lending and debt markets without the charitable aspect because at the end of the day most of the lending done is strictly for profit. One thing I took away from this article is that yes, developing countries do have access to capital but not in the same way that an industrial country does. Their ability to either issue debt or the spreads on their debt are so tied to the industrial countries that they have very little power. With that in mind I also had the same thought as Andrew, wondering what is going to happen when the Fed likely rises rates by the end of the year. We are in a period now where as the largest industrial country our yields can't go much lower and if the findings of this article are true then from here on out it is either going to discourage developing countries from issuing debt or if they do the rates will be far less attractive. While I don't think that foreign capital flows will dry up, the papers findings make it seem as thought that could be a logical conclusion.

Caroline Sanders

I’ve probably brought this up in too many of my blog posts, but I think this paper is another great example of how coordination (or lack thereof) can influence development progress in LDCs. The global credit market, at least in some aspects, seems to be another determinant of development that is shaped by complementarities. While the paper did not examine these financial relationships explicitly in the context of development, it is still an issue that pervades the paper. In their conclusion, the authors write, “global credit conditions have had an important impact on the market for developing-country debt.” Indeed, U.S. interest rates do have an impact the financial outcomes of LDCs; the authors find evidence of a negative impact of higher U.S. interest rates on developing countries borrowing behavior. If access to credit/international finance is an integral component of a country’s development strategy, than it’s ability to successfully do so is inherently dependent on exogenous conditions in global credit market.

It would be interesting to see this paper’s analysis updated to include new trends following the 2007-08 financial crisis and to note how any of the U.S.’s extraordinary (and perhaps controversial) policies like quantitative easing influence behavior in other countries. It would also be interesting to include data on developing countries in Africa and if/how their behavior differs from LDCs in East Asia and Latin America.

Lauren Howard

This paper describes the competing theories in the debate surrounding flows of international capital, particularly with respect to interest rates, and concludes by explaining the distinction between the supply/demand effects. I'm not at all familiar with this topic, so this was one of the most challenging articles for me in this class.

However, I did notice that this paper had a similar trend to past papers we've read -- it addressed commonly used, but perhaps misguided, theories and perspectives. This is a common thread to many of the articles we read in this class, and this trend sends an important message to developmental economists. We need to maintain a critical eye toward the theories that we design and implement policy based upon. As one of the past articles brought up, many developmental economists come from a modern, developed, and urban perspective -- one that is very different from many of the countries in which their economic theories would be applied.

Ali Coy

In the paper Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?, Eichengreen and Mody focus on how the state of international credit, specifically interest rates, can potentially impact capital flow to emerging markets. Unlike past analysises, this paper focused on the market for international bonds and how global credit can influence developing-country debt. Therefore, this paper concluded how “there is a negative impact of higher U.S. rates on the demand by international investors for fixed-rate issues by Latin American borrowers.” (Eichengreen and Mody). Higher interest rates affect borrower’s decision-making process to issue, as the opportunity cost is much greater. Most of the times, we, as humans, instintively think in our own self-interest and only consider how an increase or decrease in interest rates will affect our ability to spend and save. However, it is much greater than that for changes in interest rates can dramatically benefit or hurt developing countries where strong finanicial institutions do not even exist. Therefore, it is important, to understand how the Federal Reserve’s modification of interest rates can not only greatly affect our economy, but also those developing-countries who lack access to capital.

Emily Rollo

I think this paper does a very good job at explaining the flaws of previous studies on the interest rates of industrial countries and the capital flows to the developing countries. I thought it was interesting that the paper addressed the common misconception that when the US increases its interest rate, capital flows to developing countries decreases. Instead of neglecting the importance of the supply and demand responses, Eichengreen and Mody, addressed these concepts and explain the relationships between interest rates and capital flows. To me, the discussion on Latin America’s emerging markets was most interesting due to my academic interests in Latin American and Caribbean Studies. After reading this paper, I looked more into the floating-rate mechanism Mexico adapted after the Tequila crisis. During this time, Mexican markets seemed to hit rock bottom when the peso was devalued against the US dollar as a result of issuing short-term debt in dollars. Since this time, Mexico’s reserve currency stockpile has increased dramatically. Much of this improvement has to do with the introduction of the floating-rate idea in Latin America. This method seems to have curbed a lot of the shocks to the emerging markets. (http://www.institutionalinvestor.com/blogarticle/3410162/blog/how-mexico-shook-off-the-tequila-crisis.html#/.Vky3p0sdLeI) Even though the Mexican economy panicked during the early 1990s, it seems as if maybe it was “necessary” for the economy to hurt so much in order for it to realize the need for improvement and escape its debt. The Latin American countries are seeing greater returns in the long run after this implementation. I think that this is a common theme in many developing countries. However, other developing countries may not be able to understand that the long-term effects will be so beneficial, so they never take the initial steps to introduce new finance mechanisms.

Austin Tamayo

This paper discusses the relationship between interest rates in industrialized economies and cash flows into developing economies. The relationship between the two is explained using the U.S. interest rates and how it affects the demand for foreign investors. The relationship was found to be negative, as U.S. interest rates increase, the demand by foreign investors decreases. Within the conclusion, the authors wrote “Our analysis, which takes this approach to the market for international bonds, confirms that global credit conditions have had an important impact on the market for developing country debt.” What the authors are saying is that the condition of economies that have credit institutions impact the demand for credit in developing countries.
This paper reminded me of the article that talked about FDI, and the qualities of an economy that attract FDI. Differing economies have differing qualities, and for that reason, there is not a certain policy that would directly attract FDI. Similarly, there is not a single economic policy that will successfully increase the demand for credit in developing economies.

Ali Norton

This article’s discussion of lending to emerging markets and the relationship between treasury yields and quantity of bonds brought to the market demonstrated some of the factors that influence developing country’s access to capital, and how our own treasury market in the U.S. impacts international markets in developing countries. While we have talked about how individual’s gaining access to credit in developing countries can bring improved outcomes to businesses and households alike, it was interesting to look at lending on a national scale. While access to credit at an individual level can be achieved through small business and lending organizations, the mechanisms driving lending to emerging markets face entirely different factors. Since the Fed has promised to increase rates (again), the paper demonstrates how this policy shift can impact emerging markets, and impact markets in different regions differently.

This article published today covers recent comments from Fed officials about the rate hike and touches on the impact of this raise on foreign and emerging markets.


Kasey Cannon

This paper examined the link between interest rates in advanced industrial countries and the determinant of capital flows to emerging markets. Although I found this paper extremely dense, the authors did a very good job explaining the common misconception regarding foreign investment. Most people believe that falling interest rates should encourage investors to search for yield in emerging markets. Despite this making theoretical sense, much of the literature lacks support of that argument. In response to the lack of support, these authors tried to take a slightly different approach and, contrary to other recent studies, the authors found more evidence of an effect of US interest rates on emerging-market spreads.

Like several other people have alluded to in their blog post, this article reminded me of the article we read on FDI. There is no "one size fits all" solution. Thus, each developing country may require a specific policy relative to that country's conditions.

I am also curious what the most recent literature has to say about this topic since the article was written back in 1998.

Alena Hamrick

This paper reminded me a lot of Professor Silwal's lecture on FDI and the important factors that influence FDI. The key things that influence FDI that I took away from that lecture were the quality of labor, institutions, and economic status of the country that is being invested in. I think these factors are equally important in the discussion of this paper concerning capital flows and interest rates in countries. Essentially, much of it has to do with whether or not borrowing or lending is discouraged or encouraged based on the country's traits. Specifically, the paper discusses much about the spreads for East Asia and Latin America and the effects of the US interest rate and treasury yields. The latter has many implications for the supply and demand of investing for the developing countries. It's always very interesting to think about the impacts of developed nations upon developing countries, and this paper also made me think of the legacy of colonialism. The word fails to come to mind but there is a term we learned early in the year that described developing nations' dependency on the developed. This was listed as a potential reason why developing countries struggle to emerge from their low status. However, this paper made me wonder if there are not ways to manipulate capital flows and such so that a developing country may increase its FDI and its overall development.

Daniel Rodriguez-Segura

I thought that this analysis of the demand for emerging-market debt in global markets was very engaging. As some of my classmates have pointed out, by taking into account the “missing link” or the willingness to supply these debt obligations, the authors are able to explain better the financial market for national bonds. However, the paper does not go in much depth into what actually determines this demand. Certainly, the opportunity cost of supplying the debt and the international spreads can have an effect on countries deciding whether they want to issue debt or not, but so does their fiscal and financial conditions, for instance. Similarly, things like political affiliation of ruling party (more left, government spending or more right, fiscally conservative) can determine this “hunger for debt”. It is important that in most cases, countries are borrowing and expanding their balance sheets to pay for national programs or infrastructure (broadly speaking). Therefore, the demand for debt could also be determined by the different needs of a country that are not necessarily implicit in a credit rating (which they did take into account). A side comment: an interesting research question to look into is to see the relationship between increases in issuing foreign debt in global markets and population well-being with a lag. In other words, one would be exploring whether these investments are having any effect on the population. Then, one could see how things as seemingly detached to reality as “the spread” can have important effects on some countries’ population well-being.

Sarah Schaffer

Eichengreen and Mody discuss the change in interest rates in the United States and the effect credit has on the market for developing countries debt. I thought the authors did a nice job of showing a different analysis that takes into account the interest-rate effect. This article, like several of the other articles that we have read, shows that there are many factors that we need to take into account when analyzing economies in developing countries. As we discussed in class on Tuesday, it is important that developing countries have access to credit in order to grow – which is where microfinance helps. In our Economic Development book, Todaro and Smith also emphasize how microfinance institutions help stimulate a better financial system, but it is imperative that it is complemented with other growth in the country such as poverty reduction, infrastructure, etc. Eichengreen and Mody’s article shows how the decisions large industrial countries make effect this type of growth in developing countries.

Buck Armstrong

The first thing that popped into my head when reading Eichengreen and Mody's "Interest Rates in the North and Capital Flows to the South: Is there a Missing Link?" was is going to happen when the United States raises its interest rate. Most experts believe a rate hike is due this December and its been almost 6 years since the last time interest rates changed. Yet, during this time the international macroenviroment has been hit hard. So what is going to come out of the impending U.S. rate hike? Eichgreeen and Mody stated that "Other analyses, however, stressed the role of low interest rates in the industrial countries in encouraging the resurgence of capital flows to emerging markets". Additionally, higher interest rates in major money countries such as the United States has a negative impact on the borrowers' issue decision. This impending hike in interest rates might discourage investors looking to foreign countries for higher yields which might ultimately constrain foreign investment into emerging countries which greatly hinders economic growth. Safe to say it will be interest to track what happen to the U.S. economy and the international economy as a whole when the interest rates rise in a month.

Sarah Rachal

Although we have focused previously on foreign direct investments in LDCs, I did not have a solid understanding of how these investments fit into a global financial climate. Eichengreen and Mody’s paper provides a good explanation for how interest rates for bonds in industrialized, wealthy countries unintentionally impact interest rates in developing, emerging markets. The authors posit that governments in countries with emerging markets have little control over their interest rates and that these rates are instead dictated by rates in industrialized countries and especially in the United States. What most interested me was the different ways in which different regions were impacted by changes in the United States’ interest rates. The authors compared East Asia and Latin America, regions which have experienced varying levels of success in development. Latin America is strongly affected by changes in U.S. interest rates, which has caused major financial problems in the past. In contrast, East Asia is less indebted, and its markets have the ability to respond to global credit changes with more flexibility. This flexibility has allowed East Asia to maintain economic growth over a long period, regardless of changes in U.S. interest rates. Going forward, development-related organizations such as the World Bank would do well to focus on interest rates in less financially stable regions, such as Latin America and Africa, which are more strongly dependent on interest rates in industrialized countries.

Kyle Tipping

This paper seeks to discover a causal relationship between interest rate changes and the state of global financial markets, using interest rates and capital flows to emerging markets as proxy variables. The results follow an intuitive path, but curiously enough, the authors also decide to control for things such as poor credit risks dropping out of the market. This is a very important distinction to make, and is likely the problem with many of the previous studies that found results contradictory or at the very least different from what was expected. Another interesting point the authors emphasize is the distinction between a supply push and a demand pull. I had not considered thinking of capital flows in that way. As a direct result of htis, we need to use a different econometric technique, or at the very least consider this fact, to properly evaluate data. (The authors mention the flaws in OLS regressions due to this.)This added element forces us as economists to consider many different things when considering policy implications. For example, should we be considering raising interest rates (as will likely happen in the coming months in the US), we must consider whether emerging markets are trying to borrow more money and capital or not. If they are not, then raising rates would be pointless, as it would further reduce the quantity of emerging market bonds being put out, and kill spreads. If the opposite were true, then this added demand would be met by increased quantity of bonds from a developed market, and the market would shift towards an equilibrium that will likely increase global utility.

Rachael Wright

We have discussed at various times throughout the course the necessity of capital attainment in low development countries. In this paper, assumptions that a rise in developed countries' interest rates would lead to a decrease in capital flows to developing countries were proved to not always hold true. Eichengreen and Mody paint a detailed picture of the effect of U.S. interest rates on emerging markets and simultaneously highlight the limitations of other work on the topic.

In my opinion, this was certainly one of the more challenging papers in this class- my financial knowledge is relatively low making certain sections difficult to comprehend. Additionally, while interesting and educational, I could not help but bear in mind that the "present day" references were from 15+ years ago. Like others, I am interested in what an up-to-date analysis would look like seeing as a general topic of interest is the projected rate hikes this coming December.

Davis Turner

The Eichengreen and Mody article attempts to explain the underlying missing link between capital flows from developed to developing countries. The capital flows of developing countries are guided by external actors (developed countries). The interest rate and treasury yields correlates to the amount of capital flows interring a country. The relationship between US interest rates and supply and demand responses in developing countries should be considered when discussing/implementing monetary policy. High US interest rates correlate to decreasing capital flows in developing countries. Knowing that international bonds and their rates could potentially constrain the economic conditions of the poor in other countries should be taken into account when considering international economic policies.
In recent news, the Fed has discussed raising interest rates as early as December. After an increase in US hiring and a decrease of the unemployment rate to 5% this October conditions for a rate hike look more probable. From the Fed’s perspective avoiding the interest raise displays a lack of confidence in the economy. In addition, the Fed stands to gain previously ignored gains that have already been incorporated into the current economy. As rates are currently closing in on zero due to the recession the impact on the raise in rights will be felt domestically and abroad. More than likely the rate hike will be slow, but depending on economic conditions the rate could drop to near zero marks again. One must question the uncertainty of fed rates and their impacts on emerging markets.

Luke Myer

A common theme thus far in class has been the lack of access to capital in LDC’s to grow their economies. This paper talks about how the rise and fall of interest rates in financial centers, or “creditor countries” such as the United States affect foreign investment. If interest rates in the U.S. rise, it becomes more difficult to stimulate growth in the LDC’s. This causes problems for those who emphasize the importance of governments’ policies to grow their countries’ economies. Because the exogenous variable that is U.S. interest rates have such an impact on them, it is difficult for them to effectively improve their economy. It will be interesting to monitor how the impending changes in U.S. interest rates will affect the flow of financial capital in LDC’s.

Jonathan Jetmundsen

The nature and flow of capital from developed to developing countries is major point of focus for economists. I remember studying a very similar paper with Professor Grajzl that posed the question about why capital doesn't flow like some might expect. A huge take away from this paper for me was the direct impact that interest rates and debt markets in large industrial nations has on the ability of developing nations to attract investment. It is very important to remember that at the end of the day, most lenders who would provide capital are looking for the best return on their investment in the firm of higher yields than other places they could allocate their capital. It is crucial for developing countries to attract capital for investment and growth, yet it is difficult for them to do so. This paper makes an important point showing how really tied together the economies of the world are. Even though small developing countries might seem disconnected, economic and financial markets all over the world have impacts on them.

Alex Fox

Eichengreen and Mody come to a conclusion that has been common in many of our discussions on development economics and science in general. Their is no one model that can explain or accurately project the effect that US/developed economies interest rates have on global financial markets, specifically lending to LDCs. But, that doesn't mean that low interest rates doesn't translate to increased lending to developing countries. It just means that both sides of the equation must be looked at, which in this case is international lenders' willingness to lend as well as borrowers' decision to supply the obligations. Both sides must be taken into account as one side may carry more weight in different regions. In this context, it can help explain the difference in circumstances in Latin America and Asia. In sum, it is another problem of many factors that can be modeled to a certain extent as long as one understands that not all factors can be taken into account. Once again you can give a estimate as to what "might" happen.

The comments to this entry are closed.