Gross capital inflows, the U.S. economy, and the response of the Federal Reserve

In recent years, there has been a surge in capital inflows to the United States' treasury and corporate bond markets from other countries. How do these inflows affect economic activity in the United States? Does the Federal Reserve respond to such shocks? To address these important issues, we employ a sign-identified structural vector autoregressive (SVAR) model to see the effects of these types of capital inflows. Our results suggest that the U.S. economy and the Federal Reserve's balance sheet respond differently to shocks to these inflows. In particular, gross inflows to U.S. treasuries are contractionary while inflows to corporate debt are expansionary. Moreover, the Federal Reserve shrinks its balance sheet in response to shocks to gross capital inflows to U.S. treasury securities with little to no response to inflows to corporate securities. Interestingly, we find that the bulk of the Fed's response to both shocks is systematic. In this manner, the Federal Reserve's response to these shocks played only a minor role in the evolution of macroeconomic aggregates following such shocks. •We study the effects of gross capital inflows on the U.S. economy and Federal Reserve policy actions.•We find that gross inflows to U.S. treasuries are contractionary.•Further, gross inflows to U.S. corporate debt are expansionary.•The Federal Reserve shrinks its balance sheet in response to treasuries inflows.•However, the Federal Reserve's balance sheet has very little response to corporate inflows.