A varying-parameter empirical model of balance of payments determination under fixed exchange rates: Results for the UK and West Germany

The post-war period and particularly the 1960s witnessed a marked increase in the degree of international capital mobility due to various factors. Empirical studies of international financial flows during the 1960s generally assume a fixed level of capital mobility and so may suffer from structural instability. A portfolio balance model of the external account is developed which allows a varying level of capital mobility and which nests the pure monetary model (perfect capital mobility). The upshot is a varying-parameter empirical specification. This is estimated for the UK and West Germany using Kalman filtering techniques. The model performs well and indicates an upward trend in capital mobility over the period, particularly after 1968.