Dynamic relationship between foreign capital inflows and inflation: evidence from small open asian economies

This paper investigates the effects of capital inflows by type on inflation in eight small open economies in Asia using a panel VAR from 2000 to 2018. The estimation results overall indicate that the expansionary effects from aggregate demand are larger than any contractionary effects caused by the appreciation of the local currencies, and, subsequently, capital inflows have an overall positive effect on inflation. Meanwhile, the influence of disaggregated capital inflows on inflation varies, depending on the degree of financial market development and the adoption of inflation targeting (IT) in the economy's implementation of monetary policy. The estmation results suggest that it is necessary for policymaker in emerging markets to pay more attention to not only the aggregate amount of capital inflow, but also to the fluctuations within each type of capital inflow. In addition, strengthening the inflation targeting framework and developing stronger financial markets can be effective measures to cope better with the inflation pressures from capital inflows.