Capital inflows have an enormous importance in the financing of investment in emerging and transition economies. However short-term inflows, intermediated by the banking sector of the emerging economy, may be subject to early withdrawals. We model a situation where such withdrawals are motivated by a change in either the domestic or the foreign fundamentals. We show that, for a given change in fundamentals, a reversal in the capital flows (and hence a currency crisis) is more likely the more risk averse are the foreign investors into the emerging economy. We also show that a policy to tax early withdrawals may discourage capital inflows which are more likely to give rise to fundamental runs, by helping to select relatively less risk averse investors. However, such a policy would have to be fine tuned in order not to discourage all capital inflows.
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Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number
99.03.
Find related papers by JEL classification: G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment O23 - Economic Development, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
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