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How Important is the Global Financial Cycle? Evidence from Capital Flows

We quantify the importance of a Global Financial Cycle (GFCy) for capital flows. We use capital flow data disaggregated by direction and type between 1990Q1 and 2015Q4 for 85 countries, and conventional techniques, models and metrics. Since the GFCy is unobservable, we use two methods to represent it: directly observable variables in center economies often linked to it, such as the VIX, and indirect manifestations, proxied by common dynamic factors extracted from actual capital flows. Our evidence seems mostly inconsistent with a significant and conspicuous GFCy for capital flows; both methods combined rarely explain more than a quarter of the variation for most types of capital flows, in most countries, for most of the time. Succinctly, most variation in capital flows does not seem to be the result of common shocks nor stem from observables in a central country like the USA.