Capital flows and foreign interest rate disturbances in a small open economy

This article studies the dynamic response of capital flows when the economy faces a disturbance in world interest rates. The theoretical framework builds upon a fully optimizing dynamic macroeconomic model with capital accumulation and households having finite life spans. The precise path that describes the current account along the transition to the new steady state is characterized. Two extensions of die baseline model are performed. First, it is analyzed how the degree of international capital mobility affects the adjustment path of thr current account. Second, a monetary extension of the model is used to study the link between the degree of domestic financial development and the dynamics of capital flows.