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Hot money

  • V.V. Chari
  • Patrick J. Kehoe

Recent empirical work on financial crises documents that crises tend to occur when macroeconomic fundamentals are weak, but that even after conditioning on an exhaustive list of fundamentals, a sizable random component to crises and associated capital flows remains. We develop a model of herd behavior consistent with these observations. Informational frictions together with standard debt default problems lead to volatile capital flows resembling hot money and financial crises. We show that repaying debt during difficult times identifies a government as financially resilient, enhances its reputation and stabilizes capital flows. Bailing out governments deprives resilient countries of this opportunity.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 228.

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Date of creation: 2003
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Publication status: Published in Journal of Political Economy (Vol. 111, No. 6, December 2003, pp. 1262-1292)
Handle: RePEc:fip:fedmsr:228
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  1. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  2. Sachs, J. & Tornell, A. & Velasco, A., 1996. "The Mexican Peso Crisis: Sudden Death or Death Foretold?," Working Papers 96-20, C.V. Starr Center for Applied Economics, New York University.
  3. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  4. Guillermo A. Calvo, 1995. "Varieties of Capital-Market Crises," Research Department Publications 4008, Inter-American Development Bank, Research Department.
  5. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 35-54, November.
  6. Rogoff, Kenneth & Sibert, Anne, 1988. "Elections and Macroeconomic Policy Cycles," Review of Economic Studies, Wiley Blackwell, vol. 55(1), pages 1-16, January.
  7. Stephen Morris & Hyun Song Shin, 2000. "Rethinking Multiple Equilibria in Macroeconomic Modelling," Cowles Foundation Discussion Papers 1260, Cowles Foundation for Research in Economics, Yale University.
  8. Graciela Laura Kaminsky, 1999. "Currency and Banking Crises; The Early Warnings of Distress," IMF Working Papers 99/178, International Monetary Fund.
  9. Andrew Atkeson & Jose-Victor Rios-Rull, 1996. "The balance of payments and borrowing constraints: an alternative view of the Mexican crisis," Staff Report 212, Federal Reserve Bank of Minneapolis.
  10. Calvo, Guillermo A. & Mendoza, Enrique G., 1996. "Mexico's balance-of-payments crisis: a chronicle of a death foretold," Journal of International Economics, Elsevier, vol. 41(3-4), pages 235-264, November.
  11. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 2010. "A theory of Fads, Fashion, Custom and cultural change as informational Cascades," Levine's Working Paper Archive 1193, David K. Levine.
  12. Caplin, A. & Leahy, J., 1992. "Business as Usual, Market Crashes and Wisdom After the Fact," Discussion Papers 1992_18, Columbia University, Department of Economics.
  13. Chamley, Christophe & Gale, Douglas, 1994. "Information Revelation and Strategic Delay in a Model of Investment," Econometrica, Econometric Society, vol. 62(5), pages 1065-85, September.
  14. V. V. Chari & Patrick J. Kehoe, 2002. "On the robustness of herds," Working Papers 622, Federal Reserve Bank of Minneapolis.
  15. Roberto Chang & Andrés Velasco, 2001. "A Model Of Financial Crises In Emerging Markets," The Quarterly Journal of Economics, MIT Press, vol. 116(2), pages 489-517, May.
  16. Harold L. Cole & James Dow & William B. English, 1994. "Default, settlement, and signalling: lending resumption in a reputational model of sovereign debt," Staff Report 180, Federal Reserve Bank of Minneapolis.
  17. Craig Burnside & Martin Eichenbaum & Sergio T. Rebelo, 2000. "On the Fundamentals of Self-Fulfilling Speculative Attacks," NBER Working Papers 7554, National Bureau of Economic Research, Inc.
  18. Chang, R. & Velasco, A., 1998. "Financial Crises in Emerging Markets: A Canonical Model," Working Papers 98-21, C.V. Starr Center for Applied Economics, New York University.
  19. Reinhart, Carmen & Goldstein, Morris & Kaminsky, Graciela, 2000. "Assessing financial vulnerability, an early warning system for emerging markets: Introduction," MPRA Paper 13629, University Library of Munich, Germany.
  20. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
  21. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
  22. Bhattacharya, Sudipto & Detragiache, Enrica, 1994. " The Role of Multilateral Institutions in the Market for Sovereign Debt," Scandinavian Journal of Economics, Wiley Blackwell, vol. 96(4), pages 515-29.
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