Wheels within Wheels within Wheels: The Importance of Capital Inflows in the Origin of the Spanish Financial Crisis

With the creation of the Euro, the Spanish economy established an exchange rate regime similar to that adopted by many emerging economies during the 1990s. At the same time, the Eurozone as a whole adopted a currency system with features similar to the U.S. currency regime. In emerging economies, as in the U.S. economy, the adoption of these models was accompanied by strong growth in capital inflows, as well as severe financial (mostly banking) and/or macroeconomic (mostly trade) imbalances. Several authors have linked capital inflows with imbalances as cause and effect. This work uses some of those arguments, along with statistical data on the characteristics and evolution of capital inflows registered by the Spanish economy, and by the Eurozone as a whole, in order to propose a causal link between post-Euro exchange rate regimes adopted in Spain, capital inflows, and the imbalances that preceded the financial crisis of 2008.