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Capital flows and the business cycle

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  • Cuadra, Gabriel
  • Menna, Lorenzo

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.

Suggested Citation

  • Cuadra, Gabriel & Menna, Lorenzo, 2019. "Capital flows and the business cycle," Journal of Economic Dynamics and Control, Elsevier, vol. 106(C), pages 1-1.
  • Handle: RePEc:eee:dyncon:v:106:y:2019:i:c:8
    DOI: 10.1016/j.jedc.2019.07.003
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    References listed on IDEAS

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    Keywords

    Capital flows; Business cycle;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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