Capital flows and real exchange rate fluctuations following Spain's entry into the European Community

Spain's 1986 entry into the European Community was followed by a dismantling of restrictions on international capital flows. Initial trade deficits and real exchange rate appreciation were followed by trade surpluses and real exchange rate depreciation. This paper analyzes Spain's financial liberalization using a dynamic general equilibrium model with a traded and nontraded good where a capital poor country opens itself to its capital rich neighbors. A carefully calibrated model has trouble accounting for the large changes in relative prices observed given the small changes in quantities. Variants of the model with frictions in factor mobility between sectors fare better. (C) 2000 Elsevier Science B.V. All rights reserved.