Working Paper: CEPR ID: DP10502
Authors: Toni Ahnert; Enrico Perotti
Abstract: Can a wealth shift to emerging countries explain instability in developed countries? Investors exposed to political risk seek safety in countries with better property right protection. This induces private intermediaries to offer safety via inexpensive demandable debt, and increases lending into marginal projects. Because safety conscious foreigners escape any risk by running also in some good states, cheap foreign funding leads to larger and more frequent runs. Beyond some scale, foreign runs also induce domestic runs in order to avoid dilution. When excess liquidation causes social losses, a domestic planner may limit the scale of foreign inflows or credit volume.
Keywords: capital flows; unstable funding; safe haven; absolute safety
JEL Codes: F3; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| wealth shift to emerging countries (F62) | safety-seeking capital inflows into developed countries (F32) |
| safety-seeking capital inflows into developed countries (F32) | increased financial fragility (F65) |
| safety-seeking capital inflows into developed countries (F32) | domestic intermediaries offer cheap demandable debt (G21) |
| domestic intermediaries offer cheap demandable debt (G21) | higher frequency of financial runs (E44) |
| safety-seeking capital inflows into developed countries (F32) | domestic credit expansion (E51) |
| domestic credit expansion (E51) | negative net present values for marginal projects (H43) |
| foreign funding (F35) | domestic savers withdraw investments (D14) |