The Natural Level of Capital Flows

John D. Burger
Sellinger School of Business, Loyola University Maryland

Francis E. Warnock
Darden Business School, University of Virginia
NBER

Veronica Cacdac Warnock
Darden Business School, University of Virginia

This Draft: November 2019
update (in progress) of NBER Working Paper 26184

Abstract

We put forward the notion that capital flows—specifically, gross portfolio flows—fluctuate around some natural level. Our particular measure of the natural level of capital flows, denoted by KF*, is a theory-based time-varying supply-side factor, much like potential GDP is a theory‑based time‑varying supply‑side measure of economic activity. We construct KF* for 184 countries and, for the subset of countries that have quarterly time series data of capital flows, we show that KF* is a level to which flows converge in the medium term. That is, KF* appears to help identify the underlying persistent component in gross portfolio inflows by differentiating between longer-term structural flows and short-term cyclical noise. Overall, we conclude that there is a natural level of capital flows that is well approximated by our measure of KF*.