Capital flows and the structural determinants of current account variability in an open economy: An empirical analysis

M. Showkat Ali, Fordham University


This research project examines theoretically and empirically the structural relationships of current account variability, major macroeconomic policy responses and saving and investment in open economies that are linked to the international financial markets.^ This study shows that in a small open economy, terms of trade uncertainty, government spending, monetary growth, real exchange rate are important in determining the current account variability, and saving-investment comovement under perfect capital mobility. Similarly, openness ratio, GDP growth and population size are also important determinants for the saving-investment comovement and capital flows worldwide.^ This study contributes to the body of economic literature because it provides a comprehensive empirical analysis on capital flows and saving-investment comovement based on a wider set of countries, and over a longer time period than can be found in the previous literature on macroeconomic policy making in developed and developing countries.^ I have documented some descriptive statistics and econometric results that characterize both the time series and cross-country relationships among saving and investment and a number of macroeconomic policy variables for the OECD, Latin American, Subsaharan African and South East Asian countries. The key finding of the empirical analysis is that the correlation coefficient on the average for the 100 countries is 0.55 during the period 1960-1992 confirming the hypothesis that capital mobility has increased in recent years across countries. However, our results also suggest, as opposed to Feldstein-Horioka (1980) results that even high observed positive correlations between national saving and investment rates could naturally arise within a perfect capital mobility conditions where domestic policy variability and external shocks are likely to play a significant role.^ These policy variabilities in particular and the current account volatility in general give rise to differences of correlations between saving and investment across countries in their long run saving and investment behavior. The current account has a crucial intertemporal dimension too since countries, like households, are bound by an intertemporal budget constraint. In the context of saving and investment, there is a little evidence of Ricardian Equivalence in an open economy.^ By using this framework of analysis, we are able to predict effectively the reasons behind the consequences of current account variability and capital flows on one hand and inversely related saving and investment on the other. Further, the qualitative predictions of the model are consistent with recent evidence from OECD and developing countries. I empirically confirmed the theoretically predicted signs of the major variables as prescribed in open economy macroeconomics. ^

Subject Area

Economics, General|Economics, Finance|Business Administration, Banking

Recommended Citation

Ali, M. Showkat, "Capital flows and the structural determinants of current account variability in an open economy: An empirical analysis" (1996). ETD Collection for Fordham University. AAI9628327.