Capital flows, real exchange rate appreciation, and income distribution in an open economy post Keynesian model of distribution and growth

Abstract

This paper presents a post Keynesian open economy model toinvestigate the possible effects of capital flows on capacityutilization and distribution in financially controlled and financially liberalized small open economies. In financially con-trolled regimes, capital flows increase labor productivitythrough spillover effects. The increase in labor productivityleads to a decrease in wage share of workers from nationalincome which leads to lower prices. The lower price level inturn results in real exchange rate depreciation and provideshigher trade balances through enhanced export competitiveness. In financially liberalized regimes, capital flows result inreal exchange rate appreciation, which decreases the cost offoreign borrowing, foreign intermediate goods, and lowerwage shares. In line with all these developments, capacity utilization increases, but trade balances deteriorate due to diminished export competitiveness.