Working Paper: NBER ID: w22751
Authors: Ricardo J. Caballero; Alp Simsek
Abstract: 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.
Keywords: capital flows; financial stability; liquidity; fickleness; retrenchment
JEL Codes: E3; E4; F3; F4; F6; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital flows (F32) | asset prices (G19) |
| fickle foreign banks (F31) | lower resale prices (L42) |
| local banks (G21) | high valuations of foreign assets (G15) |
| decline in capital inflows (F32) | increase in stock returns (G17) |
| greater scarcity of safe assets (F65) | increase in gross capital flows (F32) |
| increase in perceived correlation between liquidity shocks (E44) | decrease in gross capital flows (F32) |