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A Model of Fickle Capital Flows and Retrenchment

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  • Ricardo J. Caballero
  • Alp Simsek

Abstract

We develop a model of gross capital flows and analyze their role in global financial stability. In our model, consistent with the data, when a country experiences asset fire sales, foreign investments exit (fickleness) while domestic investments abroad return home (retrenchment). When countries have symmetric expected returns and financial development, the benefits of retrenchment dominate the costs of fickleness and gross flows increase fire-sale prices. Fickleness, however, creates a coordination problem since it encourages local policymakers to restrict capital inflows. When countries are asymmetric, capital flows are driven by additional mechanisms, reach-for-safety and reach-for-yield, that can destabilize the receiving country.

Suggested Citation

  • Ricardo J. Caballero & Alp Simsek, 2016. "A Model of Fickle Capital Flows and Retrenchment," NBER Working Papers 22751, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22751
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    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • F6 - International Economics - - Economic Impacts of Globalization
    • G1 - Financial Economics - - General Financial Markets

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