This paper builds a stock-ﬂow consistent growth model in continuous time in order to analyze the eﬀects of policy rates in ﬁnancial centres on a small open developing economy with an open capital account and a ﬂexible exchange rate. Using a balance-sheet approach and explicitly modelling real-ﬁnancial spheres interactions and propagation mechanisms, we show that a fall in global policy rates triggers appreciation-induced boom-bust episodes in the small open economy, driven by portfolio ﬂows and cross-border lending. During the boom, public balances improve, unemployment and inﬂation fall and current account deﬁcit widens. Our results show that the boom is larger if foreign exchange market adjustment is sluggish, expectations adjust more rapidly, banking sector is monopolistic or risk perception is less sensitive to fundamentals. In the absence of productivity growth diﬀerentials between the developing economy and the rest of the world, the balance-of payments constrained growth rate is a strong attractor and the economy gravitates towards this growth rate as ﬁnancial variables and exchange rates adjust to their new levels.
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