Bank of Canada Conference on Capital Flows in Advanced Economies: Implications for Financial Stability

After increasing for several years, global capital flows saw a massive retrenchment during the global financial crisis. Much of the retrenchment in capital flows was due to a decline in cross-border banking flows between advanced economies, and has persisted. However, other components of capital flows – notably portfolio and foreign direct investments – have rebounded and have seen periods of volatility, especially during the taper tantrum.

The volatility of capital flows has led to a debate about the financial stability implications of these flows. This debate has centered around the implications for emerging economies, but large gross capital flows in advanced economies can also have important financial stability implications. In the years preceding the global financial crisis, foreign investment in US mortgage backed assets may have contributed to driving down the yields on US mortgage-backed securities and fuelling the US housing boom. During the same period, flows between euro area countries may have contributed to the low risk premiums on sovereign debt. Since the crisis, there has been a lively debate about the financial stability implications of foreign inflows into advanced economy asset markets, notably housing and bond markets.