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Capital flows under moral hazard

  • Tsyrennikov, Viktor

I analyze a model with moral hazard and limited enforcement in a small open economy. I find that when state contingent contracting is allowed adding the moral hazard friction improves the model's predictions along several dimensions. First, it justifies why non-contingent debt is an optimal way to finance an emerging economy. Second, it explains the limited consumption risk-sharing and high, volatile and counter-cyclical interest rates. Third, it generates realistic crisis-like dynamics in which capital inflows are brought to a halt and interest rates sky-rocket. The model also has a strong internal propagation mechanism.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 60 (2013)
Issue (Month): 1 ()
Pages: 92-108

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Handle: RePEc:eee:moneco:v:60:y:2013:i:1:p:92-108
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