NBER WORKING PAPER SERIES INTERNATIONAL CAPITAL FLOWS AND U.S. INTEREST RATES. Francis E. Warnock Veronica Cacdac Warnock

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1 NBER WORKING PAPER SERIES INTERNATIONAL CAPITAL FLOWS AND U.S. INTEREST RATES Francis E. Warnock Vronica Cacdac Warnock Working Papr 2560 hp:// NATIONAL BUREAU OF ECONOMIC RESEARCH 50 Massachuss Avnu Cambridg, MA 0238 Ocobr 2006 This is a rvisd vrsion of Inrnaional Financ Discussion Papr #840. Som of F. Warnock's work on his projc occurrd whn h was a Snior Economis a h Board of Govrnors. Th auhors ar indbd o Brian Sack for advic on an arlir draf. Th auhors also hank for hlpful commns Jo Gagnon, Philip Lan, Jay Shambaugh, Grac Wong, and sminar paricipans a Dardn's Financial Economics Workshop, Frddi Mac, IIIS a Triniy Collg Dublin, UVA Economics, UVA School of Archicur's Faculy Rsarch Symposium III, and h Inrnaional AREUEA confrnc in Los Cabos. addrsss for h auhors ar warnockf@dardn.virginia.du and vwarnock@virginia.du. F. Warnock hanks h Dardn School Foundaion for gnrous suppor. Th viws xprssd hrin ar hos of h auhor(s) and do no ncssarily rflc h viws of h Naional Burau of Economic Rsarch by Francis E. Warnock and Vronica Cacdac Warnock. All righs rsrvd. Shor scions of x, no o xcd wo paragraphs, may b quod wihou xplici prmission providd ha full crdi, including noic, is givn o h sourc.

2 Inrnaional Capial Flows and U.S. Inrs Ras Francis E. Warnock and Vronica Cacdac Warnock NBER Working Papr No Ocobr 2006 JEL No. E43,E44,F2 ABSTRACT Forign official purchass of U.S. govrnmn bonds hav an conomically larg and saisically significan impac on long-rm inrs ras. Fdral Rsrv crdibiliy, as vidncd by dramaic rducions in boh long-rm inflaion xpcaions and h volailiy of long ras, conribud much o h dclin of long ras in h 990s. Mor rcnly, howvr, forign flows hav bcom imporan. Conrolling for various facors givn by a sandard macroconomic modl, w sima ha had hr bn no forign official flows ino U.S. govrnmn bonds ovr h pas yar, h -yar Trasury yild would currnly b 90 basis poins highr. Our rsuls ar robus o a numbr of alrnaiv spcificaions. Francis E. Warnock Dardn Businss School Univrsiy of Virginia Charlosvill, VA and NBER warnockf@dardn.virginia.du Vronica Cacdac Warnock School of Archicur P.O. Box Charlosvill VA vwarnock@virginia.du

3 I. Inroducion For mrging mark conomis, hr is a burgoning liraur on h impac of inrnaional capial flows. For xampl, w hav larnd in rcn yars ha in mrging marks forign flows can rsul in a rducion in sysmaic risk (Chari and Hnry, 2004) and an incras in boh physical invsmn (Hnry 2000, 2003) and conomic growh (Bkar, Harvy, and Lundblad, 2005). Ths posiiv aspcs of capial flows ar mprd by h rol of forign flows in sprading criss. In conras, much lss is known abou h impac of capial flows on h largr conomis of h world. To b sur, w know ha vn in h largs counris forign flows can caus disrupion winss h ERM crisis of h arly 990s (Eichngrn, 2000) bu ousid of xrm siuaions, vidnc of any maningful impac of capial flows on larg conomis is scarc. Indd, unil rcnly many mark paricipans hld h viw ha capial flows could no possibly impac inrs ras in h Unid Sas. 2 In his papr w prsn vidnc ha inrnaional capial flows hav an conomically imporan ffc on h mos imporan pric in h largs conomy in h world, ha of h n-yar U.S. Trasury bond. Spcifically, w ascrain h xn o which forign flows ino U.S. govrnmn bond marks can hlp xplain movmns in long-rm Trasury yilds. W addrss his issu a an imporan im. No long ago, in h summr of 2003, shor-rm inrs ras wr vry low and inflaion was wll conaind. Ovr h cours of 2004, h Fdral Rsrv bgan a wll advrisd S, for xampl, Boyr, Kumagai, and Yuan (2005) and h subsanial liraur on suddn sops (among many ohrs, Calvo (998) and Mndoza and Smih (2006)). 2 For xampl, as rpord in Thir Mony, Our Srngh (Wall Sr Journal, Augus 5, 2004), David Malprass, Chif Economis of Bar Sarns, sad ha U.S. bond yilds hav flucuad ovr a wid rang in rspons o many facors bu forign buying ha(s) simply no had much impac. Forignrs don hav much influnc Many ohrs mad similar samns (alhough prhaps lss forcfully).

4 ighning cycl ha raisd shor ras whil conomic growh srnghnd and inflaion pickd up, and many mark obsrvrs prdicd an incras in long-rm U.S. inrs ras ha would rsul in subsanial losss on bond posiions (s, for xampl, Roach (2005a)). Howvr, long-rm inrs ras rmaind qui low, puzzling mark paricipans, financial conomiss, and policymakrs. W mak hr conribuions o h liraur. Firs, w provid a sraighforward mpirical prsnaion of h inrs ra implicaions of h sandard IS/LM modl. Our scond, and main, conribuion is o show by xnding h mpirical modl ha forign flows hav had a saisically and conomically significan impac on U.S. longrm ras. Our hird conribuion is ancillary bu nvrhlss imporan. Alhough h us of capial flows daa has skyrockd in rcn yars in boh praciionr and acadmic circls, hr is considrabl confusion abou such daa. W addrss his by firs highlighing som lss-han-dsirabl faurs of rpord capial flows daa and hn prsning alrnaiv masurs dsignd o addrss h dficincis. W bgin by simaing a sandard modl wihou forign flows. Th sandard modl illusras wo imporan poins. Firs, h mos imporan facor conribuing o h dclin in nominal long-rm inrs ras from 9 prcn in 987 o roughly 5 prcn by h nd of h 990s is h improvd crdibiliy of Fd policy (as masurd by rducions in boh long-rm inflaion xpcaions and h volailiy of long ras). 3 A sharp improvmn in h fiscal siuaion also hlpd for a priod, alhough mos of hos gains lar vaporad. Scond, a ims ras sm o dvia subsanially from h 3 This is consisn wih h viw ha h fixing of policy and inflaion xpcaions was a crowning accomplishmn of h Grnspan Fd (Pool, 2005). On h imporanc of fixing xpcaions whn conducing monary policy, s Eggrsson and Woodford (2003a, 2003b), Svnsson (200, 2003), and Krugman (998). 2

5 sandard modl. For xampl, ovr h pas wo yars many facors hav poind oward highr long ras monary policy has bn subsanially ighnd, h fiscal siuaion has shifd from surpluss o dficis, and inflaion and growh xpcaions hav incrasd bu an incras in long ras has no marializd. 4 W hn xnd h modl o includ forign flows. To drmin h impac of forign flows on long-rm U.S. inrs ras, wo ncssary condiions mus b saisfid. Firs, h impac mus b dcabl in ha forignrs mus b a larg nough porion of h mark o plausibly impac prics. Forignrs in U.S. db marks pass his s, as hy own jus ovr half of h Trasury bond mark. Scond, xognous forign dmand mus b idnifiabl. In Brnank, Rinhar, and Sack (2004), xognous forign flows ar idnifid hrough an vn sudy approach ha rlis on known forign xchang inrvnions by h Japans govrnmn. Howvr, h opporuniy o us such a sragy is ncssarily limid. Th Japans auhoriis acquir many U.S. Trasury bonds ousid of announcd inrvnions, and mos ohr forign govrnmns accumula U.S. scuriis in a mor salh mannr. Our idnificaion sragy rlis insad on h flows of forign govrnmn insiuions, which includ (bu ar no limid o) accumulaion by h Bank of Japan and h Popl s Bank of China, as wll as h rcycling of prodollars. Ths flows ar xognous o our modl bcaus vry fw govrnmns ra hir forign rsrvs as a porfolio o opimiz; forign govrnmns ypically hav vry broad objciv funcions ha plac a subsanial wigh on h likly impac of domsic conomic policis (Dooly, Folkrs-Landau, and Garbr, 2004). Our rsuls wih forign flows ar sriking. W find in our sampl spanning January 984 o May 2005 ha forign inflows ino U.S. bonds rduc h -yar 4 This is h conundrum of long-rm U.S. inrs ras (Grnspan, 2005). 3

6 Trasury yild by an conomically and saisically significan amoun. For xampl, if forign govrnmns did no accumula U.S. govrnmn bonds ovr h wlv monhs nding May 2005, our modl suggss ha h -yar Trasury yild would hav bn 90 basis poins highr. Furhr analysis indicas ha roughly wo-hirds of his impac coms dircly from Eas Asian sourcs. Wr forignrs o rvrs hir flows and sll U.S. bonds in similar magniuds, h simad impac would b doubld. Our papr s hird conribuion is ancillary bu nvrhlss imporan. W form bnchmark-consisn capial flows masurs ha addrss issus wih rpord capial flows daa. For h purpos of our sudy, h official sourc of U.S. capial flows, h Trasury Inrnaional Capial Rporing Sysm (TIC) daa, has wo dficincis: (i) i canno diffrnia bwn forign officials and ohr invsors whn h ransacion gos hrough a hird-counry inrmdiary and (ii) TIC-rpord flows graly ovrsima forign purchass of crain yps of U.S. govrnmn bonds. Bcaus som prominn forign govrnmns purchas U.S. scuriis hrough offshor cnrs, rcordd forign official inflows rprsn only a lowr bound. 5 On h ohr hand, h TIC daa rcords far oo many inflows ino U.S. agncy bonds. In paricular, w show ha in h on-yar priod from mid-200 o mid-2002, capial inflows ino U.S. agncy bonds wr ovrsad by $58 billion. 6 Our bnchmark-consisn flows, dscribd in full dail in h appndix, addrss boh of hs dficincis. Our rsuls ar robus o many alrnaiv spcificaions. W impos a srucur ha is consisn wih h ponial non-saionariy of nominal ras, bu o allvia any 5 Roach (2005b) sas ha U.S. daa do no capur any of h roughly $700 billion in oil procds ha may hav bn rcycld ino U.S. Trasuris in S also Economis (2005b). 6 Givn qusions abou whhr long-rm inflows can covr h U.S. currn accoun dfici (Fldsin, 2006), a $58 billion ovrsamn in a wlv-monh priod is boh sizabl and imporan. 4

7 lingring saionariy concrns w also modl ral ras. To limina h impac of shor-run businss cycl variaions, w go a sp furhr and modl fuur xpcd ral ras (h ral 5-yar forward ra fiv yars hnc). W prsn vidnc ha a viw circulad in praciionr circls ha corpora savings imporanly influnc long ras (JP Morgan, 2005) dos no impac our rsuls (nor dos i appar o hlp xplain h bhavior of long ras). W also includ inrs ra diffrnials or h ral xchang ra and, o allvia ponial concrns abou srucural braks, r-sima saring h sampl a wo significan vns, whn Grnspan bcam Chairman in Augus 987 and whn h Fd bgan announcing h arg fdral funds ra in Fbruary 994. Non of h robusnss chcks alr our main rsuls. Our rsuls ar also consisn wih h noion ha forign flows ar bhind som of h rcn flaning of h yild curv. W sima modls for a variy of U.S. inrs ras shorr rm Trasury yilds (2-yar), high and lowr qualiy corpora db (Aaa and Baa), and long-rm fixd and shor-rm adjusabl morgag ras. Th impac of forign inflows diffrs across hs insrumns, bu i is always saisically significan and ofn conomically larg. Th impac on corpora bond ras and long-rm (30-yar) fixd morgag ras is vry similar o ha on h -yar Trasury yild, bu w find ha shor-rm ras ar lss affcd by forign flows, prhaps bcaus hy ar dpr marks ha ar mor closly linkd o h fdral funds ra. Th diffrnial ffc on h wo- and n-yar Trasury yilds implis ha ovr h pas yar forign flows hav fland h yild curv by abou 50 basis poins. Our work is rlad o a numbr of srands of h liraur. Our sandard modl (wihou forign flows) complmns rcn work ha uilizs affin modls wih facors 5

8 ha ar ofn unobsrvabl (Dibold, Piazzsi, and Rudbusch, 2005; Piazzsi, 2005). Brnank al. (2004), prhaps h closs prcursor o our work, uilizs an affin rm srucur modl o idnify (domsic) macroconomic facors ha impac yilds and, spararaly, includs a high frquncy sudy of h shor-run impac of announcd Japans inrvnion. 7 Our work is also rlad bu disincly spara from h rcn liraur on h impac of ordr flow on xchang ras (Evans, 2002; Evans and Lyons, 2002) and Trasury yilds (Brand and Kavajcz, 2004; Grn, 2004). 8 Our work can b sn as ncompassing crain aspcs of h noion of a global saving glu. Brnank (2005) argus ha wo imporan facors in h global saving glu sory ar h sharp rsrv accumulaion by dvloping counris and h surg in rvnus of oil producrs. Boh mchanisms ar incorporad dircly in our prfrrd masur of forign official inflows, and our analysis suggss ha Eas Asian accumulaion is rsponsibl for abou wo-hirds of our simad impac. To h xn ha many oil producrs and som dvloping counris shun U.S. inrmdiaris, our bnchmark-consisn capial flows sris is ncssary o capur hs flows. Our papr is as follows. In h nx scion, w lay ou inrs ra implicaions from h sandard IS/LM modl, show how w opraionaliz h modl, and provid our baslin simas. In Scion III, w prsn our main rgrssion rsuls wih forign flows, as wll as various robusnss chcks. Scion IV prsns rgrssion rsuls for a broadr rang of U.S. inrs ras. Scion V concluds. In an appndix w discuss 7 Th simpliciy of our modl dos no ovrly handicap our analysis, as h fi of our baslin modl (wihou flows) is comparabl o ha of h affin rm srucur saisical modl of Brnank al. (2004). 8 Ordr flow rsarch, which xamins h impac of flows on prics, is disinc from our work bcaus i idnifis flows ha ar drivn by priva informaion. W canno mak such samns abou our flows daa, nor can mos rsarchrs; vn h rcn Evans and Lyons (2005) canno idnify ru ordr flow. 6

9 problms wih rpord capial flows daa and hn show how o rsa h daa o bring hm in lin wih highr qualiy (bu infrqun) bnchmark survys. II. A Baslin Modl of U.S. Long-Trm Inrs Ras In his scion w prsn h baslin mpirical modl, which can b hough of as a parsimonious rprsnaion of h IS/LM modl prsnd in macroconomics xbooks, and sima h modl for h priod January 984 May II.A. Opraionalizing h Sandard IS/LM Th sandard IS/LM modl can b wrin as follows: 9 r = α β Y IS () IS M r = α LM + β l P r LM Y (2) whr quaion () rprsns h IS curv, quaion (2) is h LM curv, r is h ral inrs ra, Y is oupu, M is mony supply, P is h pric lvl, and c + i + G c + x 0 0 Y 0 0 α IS = (3) cr + ir + xr l α π LM = 0 (4) lr 9 For a mor compl ramn, s Abl and Brnank (2005), Mishkin (2006), or any inrmdia macroconomics xbook. 7

10 Th consans masur auonomous consumpion (c 0 ), invsmn (i 0 ), axs ( 0 ), and xpors (x 0 ); h (ngaiv of h) snsiiviy of spnding o changs in inrs ras (c r, i r, x r ); and, for mony dmand, h auonomous componn (l 0 ) and is snsiiviy o nominal inrs ras (l r ). Th quilibrium ral inrs ra is givn by r = α LM l r M + P β + β LM IS β β LM IS α IS (5) In h shor-run IS/LM modl, prics ar assumd o b fixd, bu h modl can b appndd o includ a pric-adjusmn mchanism ha kicks in whn h conomy is away from is full mploymn lvl; for xampl, prics can b assumd o incras whn h conomy is opraing abov ponial. Th IS/LM is simpl dynamics ar limid o h assumpion concrning pric adjusmn bu i provids a rasonabl srucural spcificaion of inrs ras. I prdics ha, all ls qual, long-rm ral inrs ras will incras if any of h following incrass: xpcd fuur oupu or walh (boh of which rais c 0 ), govrnmn budg dfici, or xpcd fuur produciviy (raiss i 0 ). In addiion, anyhing ha rsuls in an xognous incras in n xpors would rais inrs ras. Furhr, inrs ras will incras if any of h following occurs: monary policy is 8

11 ighnd, pric lvl incrass, xpcd inflaion dcrass, or oupu is byond is fullmploymn lvl. Whn bringing h sandard modl o h daa, w do no aim o includ vry possibl variabl ha could fi ino h IS/LM framwork; som dgr of parsimony is, as always, dsirabl. Morovr, bcaus inrs ras ar forward-looking ass prics, w ry o rly on variabls ha ncompass forward-looking xpcaions or a las can b obsrvd in ral im. Som of h rlvan variabls corrspond nicly wih availabl daa. Shor-rm (i.., on-yar-ahad) xpcaions of fuur oupu ( y + ) and inflaion ( π availabl monhly from h Blu Chip survy. Long-rm (n-yar) inflaion π + + ) ar xpcaions ( ) ar prsnd in h Philadlphia Fd s Survy of Profssional Forcasrs; w inrpola hm o monhly figurs. W masur currn monary policy wih h arg fdral funds ra (ff ) rahr han mony supply. Th crdibiliy of monary policy imporan bcaus inrs ras ar forward looking ass prics can b capurd in par by wha w will call an inrs ra risk prmium (rp ), which w masur as h volailiy of long-rm inrs ras (calculad as h rolling 36-monh sandard dviaion of changs in long ras). 2 Th sanc of fiscal policy is a bi rickir o capur. Laubach (2003) uilizs h long-dad budg projcions of h Congrssional Budg Offic (CBO) or Offic of Managmn and Budg (OMB), bu hs projcions ar no availabl o us. Insad, w us a radily availabl masur, h An incras in xpcd inflaion, which dcrass ral ras as mony dmand falls, will incras nominal ras (bu lss han on-for-on) as long as h IS curv is no vrical (i.., as long as spnding is snsiiv o inrs ra changs). Ang, Bkar, and Wi (2005) show ha survys forcas inflaion qui wll. Anohr masur of inflaion xpcaions, TIPS, ar no y usabl for im sris analysis (Kwan, 2005), bu ar showing similar lvls as h survy daa w us. 2 This risk prmium in ffc proxis for inrs-ra and rinvsmn risk. 9

12 CBO s sris on h srucural budg dfici (dfici - ) xprssd as a prcn of laggd GDP, which w inrpola o h monhly frquncy. Our masur has on hing in common wih h long-dad projcions; bing srucural, i absracs from currn businss cycl condiions. 3 Th impac of forign conomis on domsic inrs ras in h sandard IS/LM modl is nirly hrough dmand for domsic producs. To h xn ha a dprciaion causd prhaps by inrs ra diffrnials raiss n xpors, i would b associad wih rising ral inrs ras. Similarly, an incras in forign oupu, o h xn i falls on domsic goods, would nd o incras domsic inrs ras. Along hs lins, w could includ in our baslin spcificaion a ral xchang ra or inrs ra diffrnials (or boh). In pracic, masurs of xpcd fuur oupu should pick up boh of hs faurs of h opn conomy IS/LM modl survy rspondns ar no askd o disrgard oupu ha srvs forign dmand. 4 Two variabls in h sandard IS/LM modl ar difficul o pin down. On is xpcd fuur produciviy. No only is currn produciviy difficul o masur, bu in pracic is impac in his modl dpnds crucially on how i is prcivd by individuals and firms. As Kohn (2003) poins ou, wih lags in conomic rsponss, a surg in produciviy could b associad wih ihr an incras or dcras in inrs ras (dpnding on which aspcs of h conomy happn o adjus fasr), making i vry difficul o gaug h ral-im impac of produciviy on inrs ras. Hr again w rly on on-yar ahad growh xpcaion o srv as a rasonabl proxy. Th ohr difficul-o-masur variabl is whhr oupu is byond is full mploymn lvl. 3 Morovr, as w will show, our simas of h impac of budg dficis on inrs ras ar no dissimilar from hos in Laubach (2003) or, by xnsion, Engn and Hubbard (2004). 4 As w will show, inrs ra diffrnials or xchang ras do no chang our main conclusions.

13 Indd, Orphanids and van Ordn (2004) show ha ral-im forcass of h oupu gap ar rlaivly uninformaiv. Forunaly, hr oo w hav an alrnaiv. In h horical modl, h oupu gap impacs inrs ras only hrough inflaion xpcaions, which w includ dircly. II.B. Esimaing h Sandard IS/LM Th prcding discussion suggss ha in a baslin monhly modl h -yar Trasury yild is a funcion of xpcd growh, xpcd inflaion, a risk prmium, and monary and fiscal policy. For xpcd inflaion, w us boh a long-rm (-yar) masur and, bcaus long-rm xpcaion volv only slowly, a shorr-rm (onyar) on ha w xprss rlaiv o long-rm xpcaions ( π + π + ). Explanaory variabls ar prsnd in Figur. A primary drivr in h longrrm scular dclin in nominal ras could wll b h crdibiliy of h Grnspan Fd. Indd, h xn o which long-rm rm inflaion xpcaions (Fig. a) and inrs ra movmns (Fig. b) hav bn sabilizd is rmarkabl. Long-rm inflaion xpcaions wr a 4.5 prcn whn Grnspan ook offic; by 999 hy had falln o 2.5 prcn, whr hy hav rmaind vr sinc. Similarly, h volailiy of long ras fll roughly in half from h im Grnspan bcam Chairman o 99, and hav rmaind mor or lss consan sinc. 5 Th mor bnign budg siuaion (Fig. c) ovr h lar half of h 990s also likly hlpd bring long ras down, alhough mos of h fiscal improvmn has sinc rvrsd. Finally, Figur d dpics wha many hav focusd on as a major rcn surpris. Th Fd has ighnd considrably sinc mid- 5 Figurs a and b mak an imporan poin. Incrasd Fd crdibiliy may hav hlpd rduc long-rm inrs ras ovr h cours of h 990s, bu by hs masurs hr was no furhr gain from crdibiliy sinc 999.

14 2004, and in mos prvious ighning pisods, a sharp incras in shor ras such as w hav winssd ovr h pas yar would hav rsuld in a sizabl incras in long ras. Bu, his im, dspi h sharp ighning of monary policy, long ras hav rmaind mor or lss consan a a hisorically low lvl. A final chnical no bfor w urn o h baslin rgrssions. Whn modling nominal ras w impos an assumpion abou h long-run rlaionship bwn inrs ras and inflaion xpcaions ha is consisn wih h work of Mhra (998). In paricular, w assum ha Trasury yilds ar non-saionary and ar coingrad wih h fdral funds ra and xpcd inflaion by imposing ha h cofficins on hos wo variabls sum o on. 6 As w will show, whn w modl ral inrs ras, which ar saionary, our main rsuls hold. Tabl prsns rgrssion rsuls for h baslin modl of nominal and ral - yar Trasury yilds simad using monh-avrag daa from January 984 o May For nominal long ras (column ), h mos significan drivrs of long-rm Trasury yilds ar xpcd long-run inflaion, h risk prmium, h siz of h srucural budg dfici, and h lvl of h fdral funds ra. Dclining inrs ra volailiy lowrs long ras, and, in lin wih h rsuls in Laubach (2003), a onprcnag-poin incras in h dfici-o-gdp raio incrass long ras by 24 basis poins. A on-prcnag-poin incras in long-rm inflaion xpcaions nds o incras nominal long ras by 57 basis poins, and on prcnag poin of Fd ighning rsuls in a 43 basis poin incras. Th simas suggs ha much of h 6 This rsricion assums ha ral inrs ras ar saionary. I can b shown ha imposing his rsricion is idnical o simaing h rgrssion on h yild curv slop, wih on of h rgrssors qual o h dviaion of h fdral funds ra from h long-run inflaion ra. On could argu ha all of h variabls from his alrnaiv rgrssion ar saionary. Morovr, if his rsricion wr no imposd, h impac of long-run inflaion xpcaions would bcom implausibly larg. 2

15 dcras in long ras hrough h 990s may hav owd o improvd Fd crdibiliy: h subsanial dcras in long-rm inflaion xpcaions and long ra volailiy accouns for abou half of h dcras in long ras ovr h dcad. 7 Ral long-rm ras, dfind as i π +, hav flucuad wihin a band bwn 2 and 4 prcn ovr h sampl priod. Th rgrssion (column 2) shows ha ral ras ar also significanly impacd by h risk prmium and h fdral funds ra. In conras o nominal ras, highr xpcd growh, bu no highr budg dficis, is associad wih highr ral ras. III. Th Impac of Forign Flows on U.S. Inrs Ras Th sandard macro modl provids a rasonabl rprsnaion of movmns in long-rm inrs ras. Howvr, givn rcn condiions, i prdics rising ras ovr h pas fw yars whn in acualiy ras hav rmaind roughly consan. In his scion w appnd o h baslin modl masurs of xognous forign flows. W also prsn alrnaiv modls as robusnss chcks. III.A. Forign Inflows and Long-rm Trasury Yilds Whhr forign inflows impac Trasury yilds is an opn qusion. Morovr, o our knowldg, lil if any acadmic work has bn don on his opic, prhaps bcaus capial flows daa ar no asily inrprabl. 8 7 On could also argu ha a darh of shocks buffing h conomy playd a rol, alhough ha is no dircly sabl using our modl. 8 On xcpion is Chinn and Frankl (2005), who spcula ha rcn capial flows migh b diluing radiional inrs ra rlaionships. 3

16 In his scion w prsn our xndd rgrssion modl, which uss (alrnaly) wo masurs of capial flows, dpicd in Figur 2, ha ar inndd o capur any sysmaic ffcs of xognous inflows on Trasury yilds. Th firs masur is our adjusd sris on forign accumulaion of U.S. govrnmn bonds, which w call bnchmark-consisn flows; hs ar discussd in dail in h appndix. Th scond is h TIC-rpord sris on forign official purchass of U.S. govrnmn bonds. As h discussion in h appndix maks clar, w considr h bnchmark-consisn flows o b h mor accura and h TIC-rpord official flows o b a lowr bound. Rgrssion rsuls for h xndd modl of -yar yild ha includs forign flows (consrucd as wlv-monh flows scald by laggd GDP) ar prsnd in Tabl 2. For nominal ras (columns and 2), as in h domsic modl, h cofficins on xpcd inflaion, h risk prmium, h siz of h budg dfici, and h lvl of h fdral funds ra ar highly significan. In addiion, xpcd growh bcoms significan in hs modls. Bcaus h cofficins on ( π + π + ) and π + ar of similar magniuds, in hs spcificaions shor-rm inflaion xpcaions appar o b subsanial drivrs of nominal long ras (prhaps bcaus hy adjus mor rapidly). Noably, boh forign flow variabls xhibi a significan ngaiv impac on long ras. Rsuls for ral ras (columns 3 and 4) ar similar. Compard o h rgrssions for nominal ras, h cofficin simas on h forign flows variabls ar smallr, bu forign flows sill significanly impac ral long-rm ras. Th cofficins on our wo masurs of capial flows diffr subsanially, bu hir impac on long-rm nominal ras is vry similar (Figur 3a). No ha h graph is consrucd o show how much lowr U.S. ras ar in comparison wih h cas of zro 4

17 inflows. Using bnchmark-consisn flows, had h las wlv monhs sn zro forign official purchass of U.S. Trasury and agncy bonds, our simas suggs ha cris paribus U.S. long ras would b 92 basis poins highr. 9 Th impac using TIC-rpord forign official flows which, as nod, rprsn a lowr bound is currnly 74 basis poins. Th impac of rpord TIC official inflows pakd in h summr of 2004 a abou 25 basis poins; h rducd impac sinc hn could ow in par o incrasd avoidanc of U.S. inrmdiaris by forign govrnmns, spcially hos ha ar rcycling prodollars. Figur 3b indicas ha h modl wih forign flows racks long-run ras wll (bu no prfcly), and ha rcn long-rm ras ar mor or lss in lin wih fundamnals. 20 To b sur, h figur shows ha h modl could b improvd, as a surg in ras in h mid-990s is no pickd up by h modl. Our rsuls migh srik h radr as bing larg. Bu, as Tabl 3 shows, forignrs hav bcom major paricipans in U.S. bond marks, holding ovr half h U.S. Trasury bond mark and almos on-quarr of all U.S. bonds. Gon ar h days of h la 970s whn forignrs hld lss han 5 prcn of h U.S. bond mark. Morovr, our rsuls ar in lin wih hos of ohr rsarchrs. For xampl, Laubach (2003) found ha a on-prcnag-poin incras in h budg dfici would incras long ras by 25 basis poins. Ovr h cours of 2002 and 2003 h budg dfici incrasd from nar zro o 4 prcn of GDP, which, according o h Laubach simas, would imply a 0-basis-poin impac on long ras. If w winssd a 9 Wr forign purchass o rvrs o similarly sizd sals, h impac would b doubl (84 basis poins). 20 In an arlir vrsion (Warnock and Warnock, 2005), w includd forign flows ino U.S. corpora bonds in our flows masurs. This complly liminad h currn conundrum, bu bcaus w canno b crain ha hos flows can b rad as xognous o our modl, w do no prsn hm in his papr. 5

18 similarly dramaic movmn in forign flows, our rsuls would imply a similar impac on long ras. Brnank al. (2004), in an vn sudy of Japans announcd inrvnions, found ha ach $ billion of inrvnion in h Trasury mark dprssd U.S. long ras by 0.7 basis poins. Forign inflows of $0 billion a yar (or vn $200 billion) ar no uncommon, so our magniuds ar no xorbian whn compard wih hos in Brnank al. (2004). Indd, on inrpraion is ha our rsuls gnraliz hir vn sudy findings. Th radr migh wondr whr h forign flows ar coming from. Whil counry aribuion is arguably h waks aspc of h TIC daa, i nds o b of dcn qualiy for a group of counris in Eas Asia. Panl A of Figur 4 dcomposs forign inflows ino U.S. govrnmn bonds ino hos arising from Japan, China, Hong Kong, Taiwan, and Kora (hick lin) and hos arising from ohr counris (hin lin). From h formr group coms h vas majoriy of forign official accumulaion of U.S bonds; Eas Asian purchass pakd in h summr of 2004, whn Japans accumulaion slowd considrably. Th lar group includs, among ohr hings, h rcycling of prodollars; hs ohr inflows ar sill surging, prhaps owing o rising oil rvnus. Accordingly, h impac of Eas Asian accumulaion (Panl B) is currnly only 55 basis poins, down from a high of 30 basis poins, whil ohr inflows ar now accounabl for a 3 basis poin rducion of h -yar yild. 2 2 Impacs ar compud from a modl (no shown, bu availabl from h auhors) ha is idnical o ha of Tabl 2 column, wih h xcpion ha h flows ar brokn ou ino Eas Asian and Ohr. Th cofficins ar (Eas Asia) and -0.3 (Ohr); boh ar highly significan. 6

19 III.B. Alrnaiv Spcificaions of h Exndd Modl In his subscion w prsn som alrnaiv spcificaions ha w viw as robusnss chcks. Do Corpora Savings Solv h Puzzl? JPMorgan (2005) incorporas a masur of corpora savings ino a modl of long ras; s Economis (2005a). Th logic is ha as h corpora scor movd from a n borrowr in 2000 (wih a financing gap of abou 3 prcn of GDP) o a n savr by 2004 (a slighly ngaiv financing gap), hir rducd dmand for capial should hav pu downward prssur on inrs ras. To s whhr corpora savings, rahr han forign flows, hlps xplain h puzzl, w includ a masur of h corpora financing gap (scald by GDP). Bcaus h financing gap is availabl only quarrly, for his s w uiliz a quarrly modl. W find no vidnc (Column, Tabl 4) ha h incrasd corpora savings has pu downward prssur on U.S. inrs ras; indd, h sign on h (insignifican) cofficin would suggs h opposi. Forign flows rmain conomically and saisically imporan. 22 Eliminaing h Effc of Shor-run Businss Cycl Variaions To addrss any ponial concrns abou h impac of shor-run dynamics and businss cycl flucuaions on our rgrssions, w analyz ral long-dad forward ras ha hlp addrss any ndogniy concrns rgarding our rgrssors. Our arlir 22 W wr surprisd o find rsuls ha diffrd so graly from hos in JPMorgan (2005), so w invsigad furhr. W uilizd, as hy did, daa on non-financial firms financing gap from h Fdral Rsrv s Flow of Funds Accouns (Tabl F.2 lin 59). JPMorgan appnds a masur for financial firms, alhough w wr unabl o uncovr such a masur. Bu hir appndd sris is oo similar o h rpord on o xplain h diffrnc in rsuls, which appars o ow o h sampl; hir sampl xnds back o 959, and h fw-yar priod nding 984:Q xprincd vry high inrs ras and a vry high financing gap. 7

20 rgrssions assum ha h righ-hand sid variabls do no rspond conmporanously o innovaions o h inrs ra, an assumpion ha is rasonabl and widly usd wih rgard o macroconomic variabls, which nd o b sluggish. Th assumpion is somwha lss convincing, bu is sill mainaind, wih rgard o survy xpcaions of macroconomic variabls and h currn fdral funds ra. Modling long-dad forward ras spcifically, h ral 5-5 forward ra (i.., h fiv-yar ra fiv yars hnc) using only longr-rm xplanaory variabls allvias his concrn. 23 Absracing from businss cycl considraions, ral long-rm forward ras ar lowr whn risk prmiums dcras and budg dficis ar smallr (Column 2, Tabl 4). Morovr, h cofficin simas on h forign flows variabls ar consisn wih our main rsuls. Evn absracing from h ponially confounding ffcs of businss cycl flucuaions, forign flows hav a saisically and conomically significan impac on U.S. inrs ras. Alrnaiv Sampls Thr wr a las wo imporan changs in monary policy ovr h cours of our sampl. In Augus 987, Alan Grnspan bcam Chairman of h Fdral Rsrv Board. In Fbruary 994, h Fd bgan announcing h arg Fd Funds ra; bfor hn, mark paricipans had o infr h Fd s innions by obsrving is acions in h mark. If w sar our sampl a ihr of hs das (Tabl 4, columns 3 and 4), our main rsuls ar unchangd. 23 Bcaus daa on 5-5 forward ras do no xnd back o January 984, w form hs ras using h sandard chniqu of Shillr, Campbll, and Schonholz (983). 8

21 Incorporaing Inrs Diffrnials and Exchang Ras In h sandard IS/LM modl, inrs ra diffrnials should impac h domsic inrs ra only o h xn o which hy impac h xchang ra. In urn, h channl from h xchang ra o domsic inrs ras should go hrough n xpors, which is capurd in our main rgrssions by h variabl ha masurs xpcd growh. Tha said, in Tabl 5 w dircly includ (ral) inrs ra diffrnials, r* - r, and h yar-ovr-yar chang in h ral xchang ra (rr). 24 Th rsuls ar counr o wha h modl prdics. Tha is, highr forign inrs ras (rlaiv o U.S. ras) ar associad wih a dcras in U.S. ras, and an apprciaion which should swich dmand from U.S. o forign goods is associad wih highr U.S. ras. Of cours, our simpl modl canno adqualy pick up J-curv ffcs, which is on rason w prfr o rly on h xpcd growh variabl in h baslin rgrssions. IV. Th Impac of Forign Inflows on Ohr U.S. Inrs Ras Whil h focus of our papr is on long-rm Trasury yilds, for furhr invsigaion w prsn rsuls for ohr long-rm inrs ras as wll as shor-rm ras. Our rgrssion spcificaions ar as in h prvious scion, alhough w includ on xra variabl, cycl, a ral-im indicaor of h sa of h businss cycl. 25 Th 24 Th (ral) inrs ra diffrnial is h sprad of forign ras ovr U.S. ras, whr forign ras ar compud as a simpl avrag of long ras in Grmany, Japan, and h UK. Yar-ovr-yar changs in h ral xchang ra ar compud using h Fdral Rsrv s broad ral indx, for which an incras rprsns dollar apprciaion. 25 Using ral-im daa from h Philadlphia Fd, w compu cycl as h dviaion of currn ral-im mploymn growh from is 36-monh avrag. Thr is a ponial rol for cycl in our main rgrssions, as Gurkaynak, Sack, and Swanson (2005) show ha long-rm ras adjus o mploymn rpors. Bu including cycl in our rgrssions for h -yar Trasury yild would no alr our rsuls, 9

22 businss cycl variabl plays wo rols in wha follows. Whn mploymn growh is vry wak, risk prmiums on som of h riskir bonds w considr blow migh widn, so Cycl may capur a risk prmium ffc (spara from h inrs ra risk prmium). Also, whn w urn o shorr ras ha adjus vry quickly, hr is a chanc ha our xpcaions daa ar sluggish. If so, h ral-im businss cycl variabl could pick up insananous adjusmns in xpcaions. IV. A. Rsuls for Ohr Long-Trm Ras To s if our rsuls also hold for a broadr s of U.S. long-rm inrs ras, w r-sima h rgrssions for corpora bond yilds (for boh Moody's Aaa and Baa) as wll as a 30-yar fixd morgag ra. 26 Th rsuls ar prsnd in Tabl 6. Whil h cofficin simas for som variabls diffr somwha from hos in our bnchmark rgrssions, h drivrs ar similar. In paricular, hs ohr long ras nd o b drivn by inflaion and growh xpcaions as wll as risk prmiums and policy variabls. Morovr, forign flows xhibi a subsanial impac on hs marks. IV. B. Rsuls for Shor-Trm Ras Shor-rm inrs ras ar mor closly id o h fdral funds ra, so w xpc h impac of forign flows o b mor mud. Tabl 7 confirms his for boh h 2-yar Trasury yild and h -yar adjusabl ra morgag (ARM). For boh, h cofficin on h forign flows variabl is abou half hos in prvious abls, whil h prhaps bcaus Gurkaynak al. argu ha surpriss from mploymn rpors impac long ras hrough changs in inflaion xpcaions (for which w conrol). 26 Th corpora bond ra daa is from h Fdral Rsrv Board H.5 saisical rlas ( Morgag ra daa ar from Frddi Mac's Primary Morgag Mark Survy ( 20

23 cofficin on h fdral funds ra has incrasd subsanially. No oo ha h cofficin on h businss cycl indicaor plays diffrn rols in hs rgrssions. For ARMs, cyclical waknss is associad wih highr ras, prhaps his ows o grar dmand for h lowr ras of ARMs whn unmploymn is mporarily high. In conras, for shor-rm Trasury yilds, h cofficin on h businss cycl indicaor is posiiv; cyclical waknss is associad wih a dcras in shor ras. A comparison of h cofficins on h forign flows variabls in Tabls 7 and 2 suggss ha forign flows can xplain a las som of h rcn flaning of h yild curv. In h las yar of our sampl, h -yar minus 2-yar sprad dcrasd by 47 basis poins. Our rgrssions suggs ha h diffrnial impacs of forign flows on hs ras ar associad wih 52 basis poins of his flaning. V. Conclusion This papr rprsns a firs amp a analyzing h impac of forign flows on a larg dvlopd conomy. Pas work has augh us much abou h rol of forign invsors in mrging marks. W can now add our rsuls o his liraur: Forign flows hav an conomically larg and saisically significan impac on long-rm U.S. inrs ras. Our work also suggss ha larg forign purchass of U.S. govrnmn bonds hav conribud imporanly o h low lvls of U.S. inrs ras obsrvd ovr h pas fw yars. In h hypohical cas of zro forign accumulaion of U.S. govrnmn bonds ovr h cours of an nir yar, long ras would b almos 0 basis poins highr. Bcaus som of h forign flows ow o h rcycling of prodollars, our 2

24 rsuls suggs a miigaing facor ha migh b rducing som of h bi of highr oil prics. W cauion ha alhough w prsn a muliud of robusnss ss, i is possibl ha our rsuls ovrsa h ffcs of forign flows. On migh suspc ha ohr facors no complly capurd by h rgrssors wr puing downward prssur on inrs ras ovr his priod. Thos ohr facors includ FOMC samns suggsing ha policy accommodaion would b rmovd only slowly, worris abou h risk of dflaion, or prhaps a mor bnign oulook for inflaion han suggsd by h Philadlphia Fd s survys. Sill, h facs w prsn ar suggsiv of sizabl ffcs and minnly plausibl givn ha forignrs currnly hold mor han half of h U.S. Trasury bond mark. W also rmind h radr ha h cris paribus cava srongly applis o our parial quilibrium rsuls. W quanify h impac wr all ls o rmain unchangd. Howvr, wr (for xampl) Eas Asian govrnmns o spark h ffc w prsnd, ohrs could sp in and buy, hrby allviaing h impac on U.S. ras. W can hink of hs ohrs as mark paricipans, ponially aracd by highr yilds, bu h U.S. has on xcdingly larg paricipan ha could undo any ponial ffc: h Fdral Rsrv. Wr h Fd o viw h subsqun incras in U.S. long ras as undsirabl, i has h powr o sp in and buy ihr h xac Trasury scuriis bing sold or nar-subsius such as agncy bonds. 27 Th liraur on capial flows is blossoming, and w lav plny for fuur rsarch. I would b worhwhil o modl priva forign flows o drmin hir impac on U.S. inrs ras. A modl similar o ours could b applid o ohr counris, 27 S Warnock (2006) for a mor compl discussion of ponial Fd rsponss o forign sals. 22

25 alhough Amrica s xorbian privilg (Gourinchas and Ry, 2006) and Burgr and Warnock (2006) suggs ha vry fw arac subsanial forign flows ino hir local currncy bond marks. Finally, forign flows should b incorporad ino affin rm srucur modls, as mor of hm com o idnify obsrvabl macroconomic facors. 23

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29 Svnsson, L., 200. Th Zro Bound in an Opn Economy: A Foolproof Way of Escaping from a Liquidiy Trap. Bank of Japan Monary and Economic Sudis 9, S-: Svnsson, L., Escaping from a Liquidiy Trap and Dflaion: Th Foolproof Way and Ohrs. Journal of Economic Prspcivs 7(4): Trasury Dparmn, Fdral Rsrv Bank of Nw York, and Board of Govrnors of h Fdral Rsrv Sysm, Rpor on Forign Holdings of U.S. Scuriis as of Jun 30, Warnock, F., Eas Asian Rsrvs Accumulaion and U.S. Inrs Ras. Tsimony for h U.S-China Economic and Scuriy Rviw Commission s Haring China s Financial Sysm and Monary Policis: Th Impac on U.S. Exchang Ras, Capial Marks, and Inrs Ras. Warnock, F., and C. Clavr, Financial Cnrs and h Gography of Capial Flows. Inrnaional Financ 6(): Warnock, F., and V. Warnock, Inrnaional Capial Flows and U.S. Inrs Ras. Board of Govrnors of h Fdral Rsrv Sysm, Inrnaional Financ Discussion Papr No

30 Appndix. Rpord Capial Flows Daa and Bnchmark-Consisn Flows U.S. Daa on Inrnaional Capial Flows Th mos imly sourc of U.S. daa on capial flows is h wkly H4. rlas of U.S. govrnmn scuriis hld in cusody a h Fdral Rsrv Bank of Nw York (FRBNY) on bhalf of forign official insiuions (cnral banks and financ minisris). Th wkly FRBNY cusodial daa ar asily obaind 28 and of high qualiy; misaks in FRBNY daa ar similar o a bank rcording h wrong amoun for an accoun balanc, infrqun and likly quickly corrcd. Bu h FRBNY is jus on of many cusodians ha forign govrnmns migh us. For rpord U.S. capial flows daa, FRBNY is h U.S. cusodian of choic for many of h world's cnral banks and financ minisris; a h nd of Jun 2003, 88 prcn of rpord forign official holdings of long-rm Trasury scuriis wr hld in cusody a h FRBNY. 29 Howvr, som forign govrnmns, noably Middl Eas oil xporrs bu also ohrs, avoid h FRBNY and hus his sourc is bs dscribd as only parial. A much broadr sourc han h FRBNY is h TIC sysm as a whol, of which h FRBNY daa is a subs. Th TIC sysm rpors monhly daa on forignrs purchass and sals of all yps of long-rm scuriis (quiis as wll as corpora, agncy, and Trasury bonds). 30 As such, h TIC daa givs a much fullr picur of inrnaional flows ino U.S. scuriis, alhough hy ar lss imly, bing rlasd six wks afr monh s nd. Th TIC sysm asks daa rporrs o provid informaion on h ransacions of all forignrs and, whr possibl, h subs ha can b aribud o forign official niis. Again, jus as FRBNY daa ar undrmind by forign govrnmns avoiding i as a cusodian, h spli bwn forign official and ohr forign invsors in h TIC daa is blurrd by h pracic of som forign govrnmns o us hird-counry inrmdiaris. Indd, hr is incrasing vidnc ha som govrnmns ha ar known o accumula vas amouns of U.S. Trasuris (such as oil xporrs) ar doing so hrough forign inrmdiaris. In his cas h TIC sysm may wll capur h flow, bu will no aribu i o a forign official invsor or vn h paricular counry (if, as is likly, i is xcud hrough an offshor inrmdiary). Comprhnsiv bnchmark survy daa of forign holdings ar undrmind by h us of hird-counry cusodians. Tha said, h bnchmark daa ar h mos accura and can b usd o mak an imporan poin: Of forignrs holdings of U.S. Trasury and agncy db scuriis, h majoriy is hld by forign officials. Spcifically, lowr bound simas (lowr bound bcaus som forign official holdings will show up as priva holdings) indica ha forign officials hold 63 and 35 prcn, rspcivly, of all forignrs holdings of Trasury and agncy bonds. 3 In conras, forign officials ar no kn on corpora bonds, holding only 3 prcn of h oal. On way of hinking abou his is ha govrnmns ar no usually in h businss of invsing in, or lnding o, forign corporaions. Bcaus much of rpord forignrs holdings of U.S. Trasury and agncy bonds ar hld by forign officials and i is wll known ha h TIC sysm is no abl o corrcly diffrnia bwn forign officials and ohr forign invsors (such as pnsion funds, oil sabilizaion funds, insuranc companis, and ohrs) whn h rad is mad 28 A mmo im a h boom of h firs pag of h H.4. rlas ( shows forign official holdings a h FRBNY. Th Trasury and FRBNY daa ar no dircly comparabl for a numbr of rasons; s qusion C on Trasury's FAQ si ( 29 From Tabl of Trasury al (2004) and h hisorical Major Forign Holdrs abl (availabl a forign official holdings a all U.S. cusodians oald $864 billion ($653 billion in long-rm Trasury scuriis and anohr $2 billion in shor-rm Trasury bills), of which $757 billion wr hld in cusody a FRBNY. 30 Th TIC daa also includ daa on shor-rm insrumns and on U.S. invsors rading in forign scuriis. W do no focus on shor-rm flows in his papr. 3 Trasury Dparmn al. (2005, Tabl 6). 28

31 hrough a hird-counry inrmdiary, w will uiliz ovrall TIC forign flows ino Trasury and agncy bonds in consrucing our prfrrd masur of forign official accumulaion. Th bnchmark survys can also b usd o addrss qusions abou h ovrall accuracy of TIC daa (Warnock and Clavr, 2003). Whil w hav no dirc way of knowing whhr h TIC capial flows daa ar accura, bcaus bnchmark survys of capial flows do no xis, h high qualiy scuriy-lvl bnchmark survys of forignrs' holdings of U.S. scuriis survys ha rcnly hav bn conducd annually can b usd o gaug whhr rcordd capial flows daa ar rasonably accura. Spcifically, on can form flows-basd holdings simas and compar hm wih known holdings from h bnchmark survys. Th comparison is no prfc, bcaus unknown valuaion adjusmns ar incorporad ino h markd-o-mark posiions daa, bu larg discrpancis bwn holdings givn by h comprhnsiv bnchmark survys and holdings implid from capial flows daa would indica a problm wih h flows daa. Figur A shows flows-basd holdings simas (h solid lins) and bnchmark amouns (h dos) for forignrs posiions in Trasury and agncy bonds; compl dails on h mhodology for forming h flows-basd holdings simas ar prsnd blow. For Trasury bonds, rpord TIC flows appar o hav run a bi high in h la 990s; h March 2000 sima of $,063 billion is almos $200 billion highr han h amoun collcd hrough h bnchmark survy. Sinc hn, howvr, hr is no vidnc ha TIC flows for Trasury bonds ar inaccura, as simad holdings ar righ in lin wih bnchmark amouns. Givn ha, and bcaus i is no nirly clar whhr h miss in 2000 owd o rrors in TIC daa or rrors in h bnchmark survy, w ar comforabl using TIC-rpord daa for Trasury bonds. Agncy bonds ar anohr sory: Th TIC sysm consisnly ovrsimas forignrs purchass of agncy bonds. 32 Forming Bnchmark-Consisn Flows Th discrpancy bwn flows implid from high-qualiy bnchmark survys and TIC rpord flows maks i difficul for mark paricipans o inrpr and us h TIC ransacions daa. W prsn a soluion ha uilizs h bnchmark survy daa o guid a rsamn of monhly TIC flows. Th rsuling sris, which w call bnchmark-consisn flows, will b qui similar o rpord TIC flows whn TIC flows ar in lin wih h survys. Bu whr hr is a wid discrpancy bwn TIC flows and bnchmark survys as wih agncy bonds our bnchmark-consisn flows will diffr subsanially from rpord TIC flows. To cra bnchmark-consisn capial flows daa, w rsa monhly TIC flows so ha flows-basd holdings simas ar consisn wih holdings rpord in priodic bnchmark survys. W rquir h following daa. Bilaral capial flows, or forignrs ransacions in U.S. scuriis, ar rpord monhly o h TIC Sysm, mainly by brokrs and dalrs. For U.S. long-rm db scuriis (wih original mauriy grar han on yar), hs mandaory rpors conain informaion on gross purchass and gross sals (a mark valu) and h counry of h forign counrpary o h ransacion. Th TIC daa ar availabl a Daa on forign holdings of U.S. scuriis, availabl a ar collcd in daild bu infrqun scuriy-lvl bnchmark liabiliis survys conducd in Dcmbr of 978, 984, 989, and 994; March 2000; and Jun of 2002, 2003, and Rporing o h survys is mandaory, wih pnalis for noncomplianc, and h daa rcivd ar subjcd o xnsiv 32 This ows o an inabiliy of h TIC sysm o cos-ffcivly collc daa on h priodic principal paymns on morgag-backd scuriis which should b rcordd as capial ouflows. Th TIC wb si ( dscribs h issu and provids adjusmns; howvr, hos adjusmns appar o b far oo small o limina h discrpancy. 33 Dails of h 2004 liabiliis survy, including findings and mhodology, ar discussd in Trasury Dparmn al. (2005). Grivr, L, and Warnock (200) is a primr on h survys. Th rcn annual survys ar mini survys ha srv o supplmn h quinqunnial full bnchmarks. 29