Are there different linkages of foreign capital inflows and the current account between industrial countries and emerging markets?

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.