A Model of Fickle Capital Flows and Retrenchment

78 Pages Posted: 12 Nov 2016 Last revised: 21 Dec 2018

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Alp Simsek

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: December 20, 2018

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, which can destabilize the receiving country.

Keywords: gross capital flows, global liquidity, fickleness, retrenchment, asset fire sales, capital controls, policy coordination, scarcity of safe assets, reach-for-safety, reach-for-yield

JEL Classification: E3, E4, F3, F4, F6, G1

Suggested Citation

Caballero, Ricardo J. and Simsek, Alp, A Model of Fickle Capital Flows and Retrenchment (December 20, 2018). MIT Department of Economics Working Paper No. 16-10. Available at SSRN: https://ssrn.com/abstract=2868191 or http://dx.doi.org/10.2139/ssrn.2868191

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Alp Simsek

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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