Gross capital flows and the balance-of-payments: a balance sheet perspective

By Karsten Kohler

PKES Working Paper 2019

October 2020, revised October 2020

Gross capital flows have gained increasing attention in empirical research over the last decade. Due to their effects on current accounts and financial stability, gross flows are highly relevant for key issues in macroeconomics, political economy, and public policy. However, the exact relationship between gross flows, net flows and current accounts is often poorly understood. These notes aim to clarify some basic features and implications of gross capital flows. Balance-of-payments and balance-sheet accounting is utilised to illustrate how different kinds of gross flows play out on domestic balance sheets and in the balance-of-payments. Organised around nine propositions, the notes clarify the relationship between gross flows, net flows, and trade flows; explain some interesting properties of pure financial flows; discuss issues related to exchange rates and currency unions; and clarify the nature of sudden stop crises.

Keywords: Gross capital flows, balance-of-payments, current account, imbalances, trilemma, TARGET2, sudden stop

JEL classification: F31 F32 F36 F41