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Financial Market Imperfections, Real Exchange Rates, and Capital Flows

Author

Listed:
  • Caroline Betts

    (University of Southern California)

  • Elisabeth Huybens

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

Abstract

We explore the role of domestic financial market frictions in explaining sharp movements in real and nominal exchange rates, capital flows, and output for a small open economy. Financial intermediaries arise endogenously to insulate depositors from the consequences of liquidity shocks and stochastic investment project returns, and to provide intermediation for efficient capital accumulation in the presence of a costly state verification problem. An increase in the world interest rate may provoke an increase in the fraction of credit-rationed entrepreneurs, a decrease in the steady state capital stock, and - when the elasticity of substitution between labor and capital is low - a depreciation of the real exchange rate and an outflow of capital. Hence we can account qualitatively for the recent experience of several emerging market economies in a model where all prices, including exchange rates, are perfectly flexible.

Suggested Citation

  • Caroline Betts & Elisabeth Huybens, 1999. "Financial Market Imperfections, Real Exchange Rates, and Capital Flows," Working Papers 9902, Centro de Investigacion Economica, ITAM.
  • Handle: RePEc:cie:wpaper:9902
    as

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    File URL: http://ftp.itam.mx/pub/academico/inves/huybens/9902.pdf
    File Function: First version, 1999
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    References listed on IDEAS

    as
    1. Schreft, Stacey L. & Smith, Bruce D., 1997. "Money, Banking, and Capital Formation," Journal of Economic Theory, Elsevier, vol. 73(1), pages 157-182, March.
    2. Bruce Champ & Bruce D. Smith & Stephen D. Williamson, 1996. "Currency Elasticity and Banking Panics: Theory and Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 828-864, November.
    3. Betts, Caroline M & Smith, Bruce D, 1997. "Money, Banking, and the Determination of Real and Nominal Exchange Rates," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(3), pages 703-734, August.
    4. Joydeep Bhattacharya & Mark G. Guzman & Elisabeth Huybens & Bruce D. Smith, 1995. "Monetary, Fiscal, and Bank Regulatory Policy in a Simple Monetary Growth Model," Working Papers 9501, Centro de Investigacion Economica, ITAM.
    5. Boyd, John H. & Smith, Bruce D., 1997. "Capital Market Imperfections, International Credit Markets, and Nonconvergence," Journal of Economic Theory, Elsevier, vol. 73(2), pages 335-364, April.
    6. Bhattacharya, Joydeep, et al, 1997. "Monetary, Fiscal, and Reserve Requirement Policy in a Simple Monetary Growth Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(2), pages 321-350, May.
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    More about this item

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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