Working Paper: NBER ID: w27901
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 than restricting) 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: Global financial cycle; liquidity management; emerging markets
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 |
|---|---|
| Accumulating reserves during high global liquidity periods (F65) | Favorable domestic asset prices (G19) |
| Accumulating reserves during high global liquidity periods (F65) | Reduces international borrowing costs (F34) |
| Social planner's intervention (P21) | Increase in capital flows beyond laissez-faire levels (F32) |
| Higher foreign liquidity (F65) | Higher price of domestic debt (H63) |
| Gross capital inflows (F21) | Gross capital outflows (F21) |
| Foreign exchange interventions (F31) | More beneficial in less developed financial contexts (G29) |
| Liquidity accumulation (E21) | Lower level of liquidity than socially optimal (G19) |