In this article, we attempt to evaluate the causality between the current account and foreign capital flows for the emerging markets over the period of 1980–2012, by applying the heterogeneous panel Granger causality framework. To the best of our knowledge, this is the first study that applies heterogeneous panel causality tests to explain the linkages between current account and the foreign capital flows. In addition to examining the effect of overall capital flows on the current account, we focus on the effects of different types of capital flows (foreign direct investment and portfolio investment) on the current account. We also investigate how the different types of capital flows affect gross domestic saving and gross domestic investment. We find that the causality relationship between foreign capital flows and current account is highly heterogeneous.
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