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These notes aim to clarify some basic features and implications of gross capital flows. In the context of the 2007-08 Global Financial Crisis and the 2010-12 Eurozone Crisis, trade imbalances and capital flows received a lot of attention from academics, policymakers and the media. However, there is still a great deal of disagreement and confusion around the logical and causal relationship between current accounts and capital flows.
The paper tries to clear up some misunderstandings by presenting basic facts and key results from research on gross flows from a monetary perspective. Balance-of-payments and balance-sheet accounting is utilised to illustrate how different kinds of gross flows play out on domestic balance sheets and in the balance-of-payments. The notes clarify the relationship between gross flows, net flows, and trade flows; explain some interesting properties of pure financial flows; discuss issues related to exchange rates and currency unions; and clarify the nature of sudden stop crises.
This working paper will be useful for students and non-academics who are interested in capital flows. It explains key features of capital flows within a coherent accounting framwork and tries do this in an accessible way by using simple but instructive examples.