A Model of Fickle Capital Flows and Retrenchment

Ricardo J. Caballero, Alp Simsek

NBER Working Paper No. 22751
Issued in October 2016, Revised in March 2017
NBER Program(s):Asset Pricing, Corporate Finance, Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics

We develop a global equilibrium model of capital flows that addresses the tension between their fickleness during foreign crises and retrenchment during local crises. In a symmetric world with a scarcity of safe assets, gross flows mitigate crises since the fickle flows exit the country at weak prices (or exchange rates) whereas retrenched flows are brought back at relatively high valuations. However, the fickleness of flows is not inconsequential as it induces local policymakers to tax capital flows despite their global liquidity provision benefits. If the system is heterogeneous, the model features reach-for-safety and reach-for-yield flows that can destabilize developed and emerging market economies, respectively.

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Document Object Identifier (DOI): 10.3386/w22751

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