Capital Flows and the Twin Crises: The Role of Liquidity

32 Pages Posted: 15 Feb 2006

See all articles by Ilan Goldfajn

Ilan Goldfajn

Gávea Investimentos; Pontifical Catholic University of Rio de Janeiro (PUC-Rio) - Department of Economics; Central Bank of Brazil

Rodrigo Valdés

Central Bank of Chile; Ministry of Finance, Chile

Date Written: July 1997

Abstract

This paper develops a model that focuses on the interaction of liquidity creation by financial intermediaries with capital flows and exchange rate collapses. The intermediaries` role of transforming maturities is shown to result in larger movements of capital and a higher probability of crisis. These movements resemble the observed cycle in capital flows: large inflows, crisis and abrupt outflows. The model highlights how adverse productivity and international interest rate shocks may trigger a sudden outflow of capital and an exchange collapse. The initial shock is magnified by the behavior of individual foreign investors linked through their deposits in the intermediaries. The expectation of an eventual exchange rate crisis links investors` behavior even further.

JEL Classification: F31, F34, F41

Suggested Citation

Goldfajn, Ilan and Valdés, Rodrigo O., Capital Flows and the Twin Crises: The Role of Liquidity (July 1997). IMF Working Paper, Vol. , pp. 1-32, 1997. Available at SSRN: https://ssrn.com/abstract=882594

Ilan Goldfajn (Contact Author)

Gávea Investimentos ( email )

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Pontifical Catholic University of Rio de Janeiro (PUC-Rio) - Department of Economics ( email )

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Central Bank of Brazil ( email )

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Rodrigo O. Valdés

Central Bank of Chile ( email )

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Chile
+56 2 670 2000 (Phone)
+56 2 670 2231 (Fax)

Ministry of Finance, Chile

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Santiago, 8340487
Chile

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