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Capital flow freezes

Author

Listed:
  • M. Udara Peiris

    (Oberlin College)

  • Anna Sokolova

    (University of Nevada Reno)

  • Dimitrios P. Tsomocos

    (University of Oxford)

Abstract

The period following the 2008 financial crisis focused attention on “twin-crises,” where banking crises precipitate sovereign crises due to increased bank support. We show that when private sector debt is renegotiated centrally, and bargaining power is low, it results in suboptimally low levels of debt and default rates (haircuts). If, instead, the bargaining power is sufficiently high, the supply of debt exceeds its demand and capital inflows “freeze”. These inefficiencies arise because the decentralized borrowers fail to consider how their bond supply impacts debt renegotiation outcomes, affecting both bond prices and the asset span. These issues can be addressed through macroprudential policies in the form of taxing capital inflows.

Suggested Citation

  • M. Udara Peiris & Anna Sokolova & Dimitrios P. Tsomocos, 2025. "Capital flow freezes," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 79(3), pages 853-887, May.
    • Handle: RePEc:spr:joecth:v:79:y:2025:i:3:d:10.1007_s00199-024-01604-6
    DOI: 10.1007/s00199-024-01604-6
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    More about this item

    Keywords

    Open economy; Capital flows; Capital flow freezes; Debt; Default; Renegotiation;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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