"The Global Financial Cycle and Capital Flows During the COVID-19 Pandemic"

Abstract

We estimate the heterogeneous effect of the global financial cycle on exchange rates and cross-border capital flows during the COVID-19 pandemic, using weekly exchange rate and portfolio flow data for a panel of 59 advanced and emerging market economies. We begin by estimating a global financial cycle (GFC) index at the weekly frequency with data through the end of 2021, and observe an outsized decline in the index over a period of just four weeks during February and March 2020. We then estimate the country-specific sensitivities of exchange rates and capital flows to fluctuations in the GFC. We show that the ability of the GFC to explain fluctuations in exchange rates and capital flows increased dramatically during the pandemic crisis. By using the law of the total variance we are able to decompose a panel of country-specific exchange rate or capital flow series into the time-series variance of the cross-sectional mean and the cross-sectional variance around that mean. We show that the GFC mainly explains the time-series variance of the crosssectional mean. In addition, during the pandemic crisis like the COVID pandemic in 2020, relevant high-frequency indicators such as the weekly changes in cases and vaccination rates, which varied in timing and intensity across countries, improve the cross-sectional fit of our model by just as much as standard macroeconomic fundamentals such as the current account, reserves, and net foreign assets.