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Capital flows and the business cycle

Gabriel Cuadra () and Lorenzo Menna ()

Journal of Economic Dynamics and Control, 2019, vol. 106, issue C, -

Abstract: As argued by Blanchard et al. (2015), there is a wide disconnect between the empirical evidence about the effect on output growth of global shocks to capital inflows and the theoretical predictions of standard open economy macroeconomic models. While the empirical evidence suggests that such shocks are expansionary, theory predicts that they should be contractionary. The small open economy New Keynesian model is no exception. In this paper, we build an open economy macroeconomic model that predicts that global shocks to capital inflows can indeed be expansionary. The framework consists of an extension of the open economy New Keynesian model based on a simple financial friction, and it can be expressed as a system of a few log-linear dynamic relationships. We are able to rationalize a number of puzzling facts, such as the higher output accompanied by currency appreciation that follows global shocks to capital flows, and the positive correlation between gross inflows and gross outflows.

Keywords: Capital flows; Business cycle (search for similar items in EconPapers)
JEL-codes: F32 E52 F41 (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:106:y:2019:i:c:8

DOI: 10.1016/j.jedc.2019.07.003

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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