A Model of Fickle Capital Flows and Retrenchment
78 Pages Posted: 12 Nov 2016 Last revised: 21 Dec 2018
Date Written: December 20, 2018
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: Suggested Citation