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Capital Flows and the Twin Crises

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  • Ilan Goldfajn
  • Rodrigo O. Valdés

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.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 97/87.

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Length: 32
Date of creation: 01 Jul 1997
Date of revision:
Handle: RePEc:imf:imfwpa:97/87

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  1. Barry Eichengreen, Andrew K. Rose, and Charles Wyplosz., 1995. "Speculative Attacks on Pegged Exchange Rates: An Empirical Exploration with Special Reference to the European Monetary System," Center for International and Development Economics Research (CIDER) Working Papers, University of California at Berkeley C95-046, University of California at Berkeley.
  2. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, American Finance Association, vol. 45(1), pages 49-71, March.
  3. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
  4. Jeffrey Sachs & Aaron Tornell & Andres Velasco, 1995. "The Collapse of the Mexican Peso: What Have We Learned?," NBER Working Papers 5142, National Bureau of Economic Research, Inc.
  5. Svensson, Lars E O, 1994. "Fixed Exchange Rates as a Means to Price Stability: What Have We Learned?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 872, C.E.P.R. Discussion Papers.
  6. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1993. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 108-151, March.
  7. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, Elsevier, vol. 17(1-2), pages 1-13, August.
  8. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  9. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(3), pages 401-19, June.
  10. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262061414, December.
  11. Pierre-Richard Agénor & Jagdeep S. Bhandari & Robert P. Flood, 1992. "Speculative Attacks and Models of Balance of Payments Crises," IMF Staff Papers, Palgrave Macmillan, vol. 39(2), pages 357-394, June.
  12. Postlewaite, Andrew & Vives, Xavier, 1987. "Bank Runs as an Equilibrium Phenomenon," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 95(3), pages 485-91, June.
  13. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 11(3), pages 311-25, August.
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