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NATIONAL BUREAU OF ECONOMIC RESEARCH
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A Model of Fickle Capital Flows and Retrenchment

Ricardo J. Caballero, Alp Simsek

NBER Working Paper No. 22751
Issued in October 2016, Revised in July 2019
NBER Program(s):Asset Pricing, Corporate Finance, Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics

We develop a model of gross capital flows and analyze their role in global financial stability. In our model, consistent with the data, when a country experiences asset fire sales, foreign investments exit (fickleness) while domestic investments abroad return home (retrenchment). When countries have symmetric expected returns and financial development, the benefits of retrenchment dominate the costs of fickleness and gross flows increase fire-sale prices. Fickleness, however, creates a coordination problem since it encourages local policymakers to restrict capital inflows. When countries are asymmetric, capital flows are driven by additional mechanisms, reach-for-safety and reach-for-yield, that can destabilize the receiving country.

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Document Object Identifier (DOI): 10.3386/w22751

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