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The ongoing financial globalization has instigated growing concerns on the issue of benefits and costs from free international capital mobility. Past experiences in the emerging market countries indicate that foreign capital inflows could cause persistent current account deficits and lead to currency crises. This paper empirically demonstrates that foreign capital inflows and current account imbalances interact in different ways between developed countries and emerging market countries. Using the Granger non-causality test, we find that foreign capital inflows Granger-cause the current account in the cases of emerging market countries, while a causal relation is negligently detected in the cases of developed countries. Indeed, distinct from developed countries, the current accounts of emerging market countries are susceptible to the influence of foreign capital inflows. Given the relatively immature financial markets, emerging market countries should be cautious while embracing financial globalization and prudent measures to manage large capital inflows are necessary.

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This article investigates the causal relationship between the current account and foreign capital inflows on two groups of countries, industrial countries (ICs) and emerging markets (EMs), during the time period of 1987-2006. Apart from including three sets of control variables (macroeconomic, financial, and institutional) in the regression to avoid omitted variable bias, we additionally examine whether there is a disparate interaction between gross capital inflows and the current account and between net foreign inflows and the current account. Our empirical results show that for EMs, it is mostly true that foreign capital inflow Granger causes the current account, while for ICs, it is the other way around for causality although when using gross foreign capital inflows, there is less evidence of causality detected. We also find that for EMs, after the 1997-1998 currency crises, capital inflows change the nature of their effects on the current account, particularly for Asian EMs.

Whether an undervalued currency is an attainable industrial policy for developing countries’ sustained development has recently invoked many discussions. This paper studies the case of Taiwan after first determining the misalignment of Taiwan’s currency by estimating the fundamental equilibrium real exchange rate. Three sub-periods for Taiwan’s currency exchange rate misalignment are identified: undervaluation in the periods 1981-1986 and 1998- 2008 and overvaluation during 1987-1997. Second, we use a vector autoregression (VAR) model to examine the Granger causality between exchange rate misalignment and GDP, by incorporating export and investment variables. The evidence shows that exchange rate misalignment does Granger cause GDP and it mainly comes from the third sub-period when the Taiwan dollar was undervalued. From past experience and the current economic doldrums of the last resort of global exports - the United States - currency undervaluation is not a validated strategy upon which emerging markets can wishfully impinge