IMF Working Papers

Payment Frictions, Capital Flows, and Exchange Rates

By Marco Reuter, Itai Agur, Alexander Copestake, Maria Soledad Martinez Peria, Ken Teoh

August 29, 2025

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Marco Reuter, Itai Agur, Alexander Copestake, Maria Soledad Martinez Peria, and Ken Teoh. "Payment Frictions, Capital Flows, and Exchange Rates", IMF Working Papers 2025, 171 (2025), accessed September 6, 2025, https://doi.org/10.5089/9798229022521.001

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

Cross-border payments are changing: existing intermediaries are upgrading their networks and new platforms based on novel digital forms of money are being explored, even as geoeconomic fragmentation is introducing new frictions. We develop a stylized model to assess the potential implications for the level and volatility of capital flows and exchange rates. On levels, we find that lower frictions in cross-border payments reduce UIP deviations and increase capital flows. On volatility, we find that the impact of lower frictions depends on the type of shock and the degree to which frictions decline. For real shocks, lower frictions increase capital flow volatility and reduce exchange rate volatility. For financial shocks, lower frictions increase exchange rate volatility while the impact on capital flow volatility is ambiguous. Specifically, when frictions decline by a small amount, capital flow volatility increases, while the opposite holds when the reduction in frictions is large. An increase in frictions reverses these results.

Subject: Balance of payments, Capital account, Capital flows, Current account, Exchange rate adjustments, Exchange rates, Financial services, Foreign exchange, Interest rate parity

Keywords: Capital account, Capital flows, Capital Flows, Current account, Exchange rate adjustments, Exchange rates, Exchange Rates, Global, Interest Parity, Interest rate parity, Payment Frictions

Publication Details

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