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Real Interest Rates and Productivity in Small Open Economies

Author

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  • Monacelli, Tommas
  • Sala, Luca
  • Siena, Daniele
Abstract
In emerging market economies (EMEs), capital inflows are associated to productivity booms. However, the experience of advanced small open economies (AEs), like the ones of the Euro Area periphery, points to the opposite, i.e., capital inflows lead to lower productivity, possibly due to capital misallocation. We measure capital flow shocks as (exogenous) variations in (world) real interest rates. We show that, in the data, the misallocation narrative fits the evidence only for AEs: lower real interest rates lead to lower productivity in AEs, whereas the opposite holds for EMEs. We build a business cycle model with firms' heterogeneity, financial imperfections and endogenous productivity. The model combines a misallocation effect, stemming from capital inflows, with an original sin effect, whereby capital inflows, via a real exchange rate appreciation, affect the borrowing ability of the incumbent, marginally more productive firms. The estimation of the model reveals that a low trade elasticity combined with high (low) firms' productivity dispersion in EMEs (AEs) are crucial ingredients to account for the different effects of capital inflows across groups of countries. The relative balance of the misallocation and the original sin effect is able to simultaneously rationalize the evidence in both EMEs and AEs.

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  • Monacelli, Tommas & Sala, Luca & Siena, Daniele, 2018. "Real Interest Rates and Productivity in Small Open Economies," CEPR Discussion Papers 12808, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:12808
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    Cited by:

    1. Daniele Siena, 2021. "The Euro Area Periphery and Imbalances: Is it an Anticipation Story?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 40, pages 278-308, April.
    2. Born, Benjamin & Müller, Gernot J. & Pfeifer, Johannes & Wellmann, Susanne, 2020. "Different no more: Country spreads in advanced and emerging economies," University of Tübingen Working Papers in Business and Economics 129, University of Tuebingen, Faculty of Economics and Social Sciences, School of Business and Economics.
    3. Alimov, Behzod, 2019. "Private debt, public debt, and capital misallocation," IWH-CompNet Discussion Papers 7/2019, Halle Institute for Economic Research (IWH).
    4. Jalles, João Tovar & Karras, Georgios, 2023. "Macroeconomic volatility and the current account: Extending the evidence," Economic Modelling, Elsevier, vol. 125(C).
    5. Mikhail Mamonov & Anna Pestova, 2023. "The Price of War: Macroeconomic and Cross-Sectional Effects of Sanctions on Russia," CERGE-EI Working Papers wp756, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    6. Xia, Tian & Zhou, Hang, 2023. "Commodity terms of trade co-movement: Global and regional factors," Journal of International Money and Finance, Elsevier, vol. 139(C).

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    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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