Real Interest Rates and Productivity in Small Open Economies

54 Pages Posted: 26 Mar 2018

See all articles by Tommaso Monacelli

Tommaso Monacelli

Bocconi University - Department of Economics

Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER)

Daniele Siena

Banque de France

Multiple version iconThere are 2 versions of this paper

Date Written: March 2018

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.

JEL Classification: F32, F41

Suggested Citation

Monacelli, Tommaso and Sala, Luca and Siena, Daniele, Real Interest Rates and Productivity in Small Open Economies (March 2018). CEPR Discussion Paper No. DP12808. Available at SSRN: https://ssrn.com/abstract=3149479

Tommaso Monacelli (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER) ( email )

Via Roentgen 1
Milan, 20136
Italy
+39 02 5836 3326 (Phone)

Daniele Siena

Banque de France ( email )

Paris
France

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