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Capital Accumulation and Real Exchange Rate Behavior in a Small Open Economy with Credit Market Frictions

Author

Listed:
  • Gaetano Antinolfi

    (Cornell University)

  • Elisabeth Huybens

    () (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM))

Abstract

We consider the nature of the relationship between the real exchange rate and capital formation. We present a model of a small open economy that produces and consumes two goods, one tradable and one not. Domestic residents can borrow and lend aborad, and costly state verification (CSV) is a source of frictions in domestic credit markets. The real exchange rate matters for capital accumulation because it affects the potential for investors to provide internal finance, which mitigates the CSV problem. We demonstrate that the real exchange rate must monotonically approach its steady state level. However, capital accumulation need not be monotonic and real exchange rate appreciation can be associated with either a rising or a falling capital stock. The relationship between world financial market conditions and the real exchange rate is also investigated.

Suggested Citation

  • Gaetano Antinolfi & Elisabeth Huybens, 1996. "Capital Accumulation and Real Exchange Rate Behavior in a Small Open Economy with Credit Market Frictions," Working Papers 9604, Centro de Investigacion Economica, ITAM.
  • Handle: RePEc:cie:wpaper:9604
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    Cited by:

    1. Stefan Krasa & Tridib Sharma & Anne Villamil, 2008. "Bankruptcy and firm finance," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 36(2), pages 239-266, August.
    2. Antunes, António & Cavalcanti, Tiago & Villamil, Anne, 2008. "Computing general equilibrium models with occupational choice and financial frictions," Journal of Mathematical Economics, Elsevier, vol. 44(7-8), pages 553-568, July.
    3. Nicholas Apergis & Costantinos Katrakilidis & Nikolaos Tabakis, 2006. "Dynamic Linkages between FDI Inflows and Domestic Investment: A Panel Cointegration Approach," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 34(4), pages 385-394, December.

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