Munich Personal RePEc Archive

Foreign Capital Flows, Real Exchange and Interest Rates: An Analytical Framework

Goyal, Ashima (1997): Foreign Capital Flows, Real Exchange and Interest Rates: An Analytical Framework. Published in: Journal of Foreign Exchange and International Finance , Vol. 9, No. 3 (1997): pp. 215-232.

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Abstract

We build a framework to explain surges in capital flows, volatility in real exchange and interest rates and derive implications for policy. Our framework is adapted to the features of a labour surplus developing country with a large share of non-traded goods, and focuses on the medium-run. Classes of high and low growth equilibria are shown to occur. Movements in expected and actual real exchange rates, reinforce those in normalized output and inflation. In such circumstances, a traditional monetary stabilization, following on a supply shock or surge in foreign inflows, can lead to an overshooting of the real rate of interest or the exchange rate and raise inflation from the supply side. Careful coordination of monetary and fiscal policies can, however, shift the economy to the high growth path and minimize fluctuations.

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