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Do Capital Flows Reflect Economic Fundamentals in Developing Countries?

  • Atish R. Ghosh
  • Jonathan David Ostry

This paper proposes a methodology for testing whether capital flows to developing countries are determined by economic fundamentals or by purely speculative forces. We use the intertemporal optimizing approach to current account determination as our benchmark for judging the behavior of capital flows. According to this approach, capital flows should act as a buffer to smooth consumption in the face of temporary shocks to national cash flow, defined as output less investment less government expenditures. The results are encouraging. For a large sample of developing countries, economic fundamentals are indeed found to be the most important determinant of capital flows.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 93/34.

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Length: 46
Date of creation: 01 Apr 1993
Date of revision:
Handle: RePEc:imf:imfwpa:93/34
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  1. John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," Cowles Foundation Discussion Papers 785, Cowles Foundation for Research in Economics, Yale University.
  2. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  3. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters, in: A Theory of the Consumption Function, pages 1-6 National Bureau of Economic Research, Inc.
  4. Enrique G. Mendoza, 1992. "Robustness of Macroeconomic Indicators of Capital Mobility," IMF Working Papers 92/111, International Monetary Fund.
  5. Campbell, John Y, 1987. "Does Saving Anticipate Declining Labor Income? An Alternative Test of the Permanent Income Hypothesis," Econometrica, Econometric Society, vol. 55(6), pages 1249-73, November.
  6. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1993. "“Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," MPRA Paper 7125, University Library of Munich, Germany.
  7. Donald J. Mathieson & Liliana Rojas-Suárez, 1992. "Liberalization of the Capital Account; Experiences and Issues," IMF Working Papers 92/46, International Monetary Fund.
  8. Harberger, Arnold C, 1980. "Vignettes on the World Capital Market," American Economic Review, American Economic Association, vol. 70(2), pages 331-37, May.
  9. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, 07.
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