Rue de la Banque no. 34: Economic policy uncertainty in advanced countries and portfolio capital flows to emerging markets

Uncertainty in advanced countries’ economic policies spills over to emerging markets via portfolio bond and equity flows. A negative uncertainty shock in an advanced country has two opposing effects on portfolio flows: i) it can trigger a portfolio rebalancing in the form of flows towards other economies; and ii) it can prompt a flight to quality, potentially leading to a reduction in flows to EMEs. Flights to quality tend to be more marked during periods of stress in global financial markets, so that an uncertainty shock that might have had a positive impact during a “tranquil” period can instead have a negligible or even negative impact. For example, an increase in policy uncertainty in the United States has no effect on equity flows to EMEs during calm periods, but a negative impact during periods of heightened global risk.