The impact of foreign capital flows on long‐term interest rates in emerging and advanced economies

AbstractThis paper explores how foreign capital flows affect domestic long‐term interest rates. This is especially important in emerging economies when compared with advanced economies. We employ panel data to infer the yields of 10‐year government bonds along with the government bond inflows associated with foreign investors. We then use a regression approach to examine the differences in the interest rate effects between emerging and advanced economies before and after the global financial crisis (GFC). The results suggest that while government bond inflows influenced the government bond yields of emerging economies after the GFC, this was not the case for them before the GFC nor in small advanced economies before or after the GFC. Further, we find the purchase (sale) of government bonds by foreign investors corresponded to large decreases (increases) in emerging economy bond yields. Overall, the findings suggest that the massive government bond inflows associated with foreign investors after the GFC exerted a significant impact on long‐term interest rates in emerging economies.