AbstractThe conventional wisdom is that capital flows between developing countries and developed countries are more volatile than can be justified by fundamentals. In this paper we construct a simple model in which frictions in international financial markets in combination with standard debt-default problems lead to volatile capital flows. These flows act as tests of fire for borrowing countries. If a country survives this test, its reputation is enhanced and future capital flows become less volatile. Failing this test is associated with a loss of reputation and a decline in the amount of capital flows.
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Date of creation: 14 Mar 2003
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-03-19 (All new papers)
- NEP-DGE-2003-03-19 (Dynamic General Equilibrium)
- NEP-MAC-2003-03-19 (Macroeconomics)
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