Exchange Rate Reconnect: Capital Flows and Currency Dynamics joint with Andrew Lilley, Matteo Maggiori and Brent Neiman

Abstract:

We demonstrate that exchange rates comove strongly with global capital flows since the Global Financial Crisis. This connection between exchange rates and global capital flows offers a partial resolution to the “exchange rate disconnect puzzle.” We find that the broad dollar exchange rate tends to depreciate by 0.55% for every 1% US net purchase of foreign securities. These US portfolio outflows account for roughly 30% of the variation in the broad dollar in the post-crisis period. Using a novel micro-dataset of global capital flows, we examine the channels through which exchange rates and capital flows have become reconnected.