The Relationship between Capital Flows and Current Account: Volatility and Causality

Abstract

This paper examines the relationship between net private capital inflows and the current account in a set of industrial and developing countries. The first question asks whether the cyclical volatility in current accounts can be explained by the volatility of capital flows. The second question addresses the causal link between net capital inflows and current account imbalances. There is evidence in our data that inflows do cause current account imbalances in the developing countries. In contrast, the evidence implies that inflows do not cause current account imbalances in the industrial countries, nor does the inflow volatility affect current account volatility.