This paper examines the behavoir of capital inflows and the real exchange rate in Brazil during the period 1988-95. The first part describes the analytical framework. The second part estimates (using monthly data) a near-VAR linking capital flows, changes in domestic and foreign nominal interest rates, changes in the expected depreciation rate, the government spending-output ratio, and changes in the real exchange rate. Generalized variance decompositions indicate that world interest rate shocks explain only a fraction of medium-term fluctuations in capital flows, whereas fluctuations in the real exchange rate are driven mostly by its own innovations. Generalized impulse response functions show that a reduction in the world interest rate leads on impact to a fall in domestic interest rates, a reduction in the rate of nominal exchange rate appreciation, a capital inflow, and a depreciation of the real exchange rate.