The real exchange rate, saving and investment: The case of capital controls

This thesis examines saving and investment and their relationship with the real exchange rate for a small open economy. Chapter 1 is a literature survey that discusses terms of trade disturbances and the coefficient of saving and investment. In the same manner that Feldstein and Horioka examine the relationship between saving and investment; and, find that the coefficient should tell something about the extent of capital mobility in the world, we seek to find a meaning for the coefficient of saving/investment and the real exchange rate. With that coefficient, we study the effects of capital controls imposed by the policymakers of a small open economy. I develop theoretical models in chapters 2 and 3. The model in chapter 2 is a conventional wisdom model in which the real exchange rate is exogenous. The capital controls take the form of a quota on capital flows. The model in chapter 3 is a utility-maximization model in which the real exchange rate is exogenous. We find that the saving-real exchange rate coefficient is domestic demand for domestic and import goods relative to domestic output. Models are derived for the cases of free trade, capital controls, tariffs, and policy combinations of tariffs and capital controls. The utility-maximization model is simulated in chapter 4. In chapter 5 we regress saving and investment against the real exchange rate. Empirical estimates are estimated for 7 industrial nations and 21 developing countries. With panel data estimation, we find that the coefficient is greater with freer exchange rate regimes.