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Boom‐and‐bust Cycles, External Imbalances and the Real Exchange Rate
Author(s) -
MüllerPlantenberg Nikolas A.
Publication year - 2017
Publication title -
the world economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.594
H-Index - 68
eISSN - 1467-9701
pISSN - 0378-5920
DOI - 10.1111/twec.12322
Subject(s) - economics , current account , exchange rate , balance of payments , monetary economics , net foreign assets , currency , portfolio , bust , capital flows , global imbalances , net capital rule , capital account , position (finance) , boom , capital (architecture) , financial economics , finance , microeconomics , profit (economics) , archaeology , environmental engineering , history , engineering
When the current account balance and net capital outflows do not exactly offset each other, international payment flows arise. Payment flows into a country push the real exchange rate up, payment outflows push it down. This article uses a model of optimal consumption and portfolio choice to determine the factors that drive international payment flows during boom‐and‐bust cycles. It shows that during such episodes, capital inflows first exceed the deficit on current account, strengthening the currency. Later on, when the return on domestic capital reverts to its normal level, the current account recovers, yet the overall decline of the net foreign asset position provokes a fall of the real exchange rate even below its initial level. Case studies of countries experiencing rapid economic expansions followed by economic and financial meltdowns confirm the article's theoretical predictions.