Capital flows and real effective exchange rate in developing countries

Abstract

This paper carries out a theoretical analysis and empirical investigation regarding the relationship between capital flows and real effective exchange rate in developing countries. With a sample of 63 developing countries during the period 1980-2010, equations for the real effective exchange rate will be estimated, including between the explanatory variables measures of capital flows. The results suggest that: (i) there is evidence that capital flows cause exchange rate appreciation; (ii) there is no evidence that the effect of capital flows on the real effective exchange rate depends on the level of institutional development in the countries; (iii) there is fragile evidence that the effect of capital flows on the real effective exchange rate depends on the level of financial development in the countries, so that a higher level of financial development mitigates currency appreciation caused by capital flows.