The surge in capital flows: analysis of ‘pull’ and ‘push’ factors

Abstract

This paper uses an intertemporal optimizing model of a small open economy facing imperfect world capital markets to assess the effects of ‘pull’ and ‘push’ factors on capital flows, asset accumulation, and the real exchange rate. A positive money demand shock raises consumption and holdings of foreign assets and appreciates the real exchange rate in the long run; it has an ambiguous effect on real money balances on impact. A positive productivity shock in the traded goods sector also leads to a long-run real appreciation (the Balassa-Samuelson effect), but the impact effect on relative prices is ambiguous. An increase in government spending on home goods leads to a real appreciation in the long run, but it has an ambiguous effect on the economy’s stock of net foreign assets. The dynamic effects associated with a reduction in the world interest rate depend on the degree of intertemporal substitution in consumption and the initial asset position of private agents. © 1998 John Wiley & Sons, Ltd.