The Effects of External Capital Flows on Developing Countries: Financial Instability or "Wrong" Prices?

This paper discusses the effects of capital movement on developing economies whose production structures are highly dependent on foreign technology and imports. It is argued that, instead of increasing savings and investment and maximizing economic growth, external capital flows induce financial instability, which modify "key" prices and depress economic activity. This analysis is based on the assumption that money is endogenous and the rate of interest is exogenous; the exchange rate induces inflation with a magnified pass-through effect to consumers, and the rate of interest is a distributional variable whose main objective is to restore financial gains.