Boom-and-bust cycles marked by capital inflows, current account deterioration and a rise and fall of the real exchange rate

Nikolas Müller-Plantenberg ()

No 2012/10, Working Papers in Economic Theory from Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History)

Abstract: When the current account balance and net capital outflows do not exactly offset each other, net payment flows arise. Payment inflows into a country push the real exchange rate up, outflows push it down. This paper uses a model of optimal consumption and portfolio choice to determine the factors that drive international payment flows during boom-and-bust cycles. It shows that during such cycles, capital inflows first exceed the deficit on current account, strengthening the currency. Later on, when returns on domestic investments revert to their normal levels, the current account recovers, yet the overall decline of the international investment position provokes a fall of the real exchange rate even below its initial level. Case studies of countries experiencing rapid economic expansions followed by financial collapse confirm the paper’s theoretical predictions.

Keywords: boom-and-bust cycles; optimal consumption and portfolio choice; capital inflows; current account deterioration; currency flows; crises. (search for similar items in EconPapers)
JEL-codes: F31 F32 F34 G01 G11 N10 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2012-03
New Economics Papers: this item is included in nep-ifn and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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