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A Model of Fickle Capital Flows and Retrenchment

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 hav...

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Bibliographic Details
Published in:The Journal of political economy 2020-06, Vol.128 (6), p.2288-2328
Main Authors: Caballero, Ricardo J., Simsek, Alp
Format: Article
Language:English
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Summary: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 policy makers 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.
ISSN:0022-3808
1537-534X
DOI:10.1086/705719