Does capital mobility finance or cause a current account imbalance?

Using the Granger non-causality test, we find that the current account mostly Granger-causes the financial account of developed countries. For emerging market economies, however, the causality turns the other way around, although in the short run, depending upon the policy response imposed by each individual country toward the capital flows, there might be mixed results regarding the causality between the current account and the financial account. The financial account, as implied by its name, serves to finance the current account imbalance of developed countries, while capital mobility could push the current account into a state of imbalance in the case of emerging market economies. In addition, the causal results between the components of the financial account and the current account show that each component has different causal relationships with the current account. This means that countries without a sophisticated and sound financial system to channel funds to the proper location should exercise caution and not abruptly remove their restrictions on capital mobility. The pace and sequence of financial account liberalization should be heeded as well.