Capital Inflows and the Real Exchange Rate: Can Financial Development Cure the Dutch Disease?

Christian Saborowski

No 09/20, IMF Working Papers from International Monetary Fund

Abstract: This paper argues that, in improving the efficient allocation of resources, financial sector development could dampen the appreciation effect of capital inflows. Using dynamic panel data techniques, the paper finds that the exchange rate appreciation effect of FDI inflows is indeed attenuated when financial and capital markets are larger and more active. The main implication of these results is that one of the main dangers associated with large capital inflows in emerging markets-the destabilization of macroeconomic management due to a sizeable appreciation of the real exchange rate-can be mitigated partly by developing a deep financial sector.

Keywords: Capital inflows; Real effective exchange rates; Capital markets; Emerging markets; Financial sector; Economic models; Cross country analysis; Statistical annexes (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-opm
Date: Written
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