The 1990s appreciation of the US$ has been blamed on the “irrational exuberance” of investors in the US IT boom. A core of these investors appeared to believe that technology-related productivity growth (due, in part, to knowledge spill-over externalities) would raise the relative US rate of return over a sustained period. This paper introduces a two country, dynamic general equilibrium model with international financial capital mobility and trade to investigate the conditions under which a single technology shock could cause such a sustained change in capital flows. We find that a once-off productivity shock, whether in the presence of (small-medium) externalities or not, leads to capital inflow and a real appreciation in the short term but is followed in the long term by a stabilisation of the capital account and a net depreciation of the real exchange rate. For a single shock to trigger long-term growth in relative capital returns appears to require unrealistically large externalities. The presence of adaptive expectations can lead to persistence and cyclical behaviour in the real exchange rate and current account.
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Paper provided by Australian National University, Centre for Applied Macroeconomic Analysis in its series CAMA Working Papers with number
2007-16.
Find related papers by JEL classification: F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements F31 - International Economics - - International Finance - - - Foreign Exchange F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
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