A Model of Fickle Capital Flows and Retrenchment
NBER Working Paper No. 22751
We develop a model of gross capital flows that addresses the tension between their fickleness during foreign crises and retrenchment during local crises. In a symmetric environment with domestic crises, capital flows mitigate fire sales since fickle inflows exit the crisis location at weak prices whereas past outflows provide liquidity at higher valuations. However, due to the public good aspect of flows’ liquidity services, local policymakers with financial stability concerns may restrict flows. Greater scarcity of safe assets and lower correlation between crises increase gross flows. With asymmetric locations, the model features reach-for-safety and reach-for-yield flows that can be destabilizing.
Document Object Identifier (DOI): 10.3386/w22751
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