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Hot Money and Serial Financial Crises

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  • Anton Korinek

Abstract

When one region of the world economy experiences a financial crisis, the world-wide availability of investment opportunities declines. As global investors search for new destinations for their capital, other regions will experience inflows of hot money. However, large capital inflows make the recipient countries more vulnerable to future adverse shocks, creating the risk of serial financial crises. This paper develops a formal model of such flows of hot money and the vulnerability to serial financial crises. It analyzes the role for macro-prudential policies to lean against the wind of such capital flows so as to offset the externalities that occur during financial crises. Summarizing the results of our model in a simple policy rule, the paper finds that a 1 percentage point increase in a country's capital inflows/GDP ratio warrants a 0.87 percentage point increase in the optimal level of capital inflow taxation.

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal IMF Economic Review.

Volume (Year): 59 (2011)
Issue (Month): 2 (June)
Pages: 306-339

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Handle: RePEc:pal:imfecr:v:59:y:2011:i:2:p:306-339

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References

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  1. Anton Korinek & Agustín Roitman & Carlos A. Végh, 2010. "Decoupling and Recoupling," NBER Working Papers 15907, National Bureau of Economic Research, Inc.
  2. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 16270, University Library of Munich, Germany.
  3. Mendoza, Enrique G, 2001. "The Benefits of Dollarization When Stabilization Policy Lacks Credibility and Financial Markets Are Imperfect," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 440-74, May.
  4. Kristin J. Forbes, 2005. "The Microeconomic Evidence on Capital Controls: No Free Lunch," NBER Working Papers 11372, National Bureau of Economic Research, Inc.
  5. Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers 534, Board of Governors of the Federal Reserve System (U.S.).
  6. Reinhart, Carmen & Reinhart, Vincent, 2008. "Capital Flow Bonanzas: An Encompassing View of the Past and Present," CEPR Discussion Papers 6996, C.E.P.R. Discussion Papers.
  7. James Tobin, 1978. "A Proposal for International Monetary Reform," Cowles Foundation Discussion Papers 506, Cowles Foundation for Research in Economics, Yale University.
  8. Jeanne, O. Prof.Dr. & Korinek, A., 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," Discussion Paper 2010-108S, Tilburg University, Center for Economic Research.
  9. Nicolas E. Magud E. & Carmen M. & Kenneth S. Rogoff, 2011. "Capital Controls: Myth and Reality--A Portfolio Balance Approach," Working Paper Series WP11-7, Peterson Institute for International Economics.
  10. Korinek, Anton, 2011. "Foreign currency debt, risk premia and macroeconomic volatility," European Economic Review, Elsevier, vol. 55(3), pages 371-385, April.
  11. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973, March.
  12. Anton Korinek, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
  13. Kosuke Aoki & Gianluca Benigno & Nobuhiro Kiyotaki, 2009. "Capital Flows and Asset Prices," CEP Discussion Papers dp0921, Centre for Economic Performance, LSE.
    • Kosuke Aoki & Gianluca Benigno & Nobuhiro Kiyotaki, 2009. "Capital Flows and Asset Prices," NBER Chapters, in: NBER International Seminar on Macroeconomics 2007, pages 175-216 National Bureau of Economic Research, Inc.
  14. Ricardo J. Caballero & Arvind Krishnamurthy, 2003. "Excessive Dollar Debt: Financial Development and Underinsurance," Journal of Finance, American Finance Association, vol. 58(2), pages 867-894, 04.
  15. Nguyen, Ha, 2010. "Credit constraints and the north-south transmission of crises," Policy Research Working Paper Series 5408, The World Bank.
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Cited by:
  1. Joseph E. Stiglitz, 2011. "Rethinking Macroeconomics: What Failed, And How To Repair It," Journal of the European Economic Association, European Economic Association, vol. 9(4), pages 591-645, 08.
  2. Anton Korinek, 2011. "The New Economics of Capital Controls Imposed for Prudential Reasons," IMF Working Papers 11/298, International Monetary Fund.

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