Working Paper: CEPR ID: DP15328
Authors: Olivier Jeanne; Damiano Sandri
Abstract: We use a tractable model to show that emerging markets can protect themselves from the global financial cycle by expanding (rather thanrestricting) capital flows. This involves accumulating reserves when global liquidity is high to buy back domestic assets at a discount when global financial conditions tighten. Since the private sector does not internalize how this buffering mechanism reduces international borrowing costs, a social planner increases the size of capital flows beyond the laissez-faire equilibrium. The model also provides a role for foreign exchange intervention in less financially developed countries. The main predictions of the model are consistent with the data.
Keywords: capital flows; foreign exchange reserves; sudden stop; capital flow management; capital controls
JEL Codes: F31; F32; F36; F38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expanding capital flows (F32) | protection from the global financial cycle (F65) |
| accumulation of reserves (E22) | repurchase of domestic assets at discounted prices (F31) |
| social planner's intervention (P21) | capital flows beyond laissez-faire equilibrium (F32) |
| gross capital inflows (F21) | gross capital outflows (F21) |
| size of external liabilities (F34) | borrowing spread (G21) |
| size of foreign liabilities (F65) | foreign exchange interventions (F31) |
| capital flow management (F32) | financial stability in emerging markets (F65) |