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This paper shows how foreign exchange intervention can be used to avoid a sudden stop in capital flows in a small open emerging market economy. The model is based around the concept of an under-borrowing equilibrium defined by Schmitt-Grohe and Uribe (2020). With a low elasticity of substitution between traded and non-traded goods, real exchange rate depreciation may generate a precipitous drop in aggregate demand and a tightening of borrowing constraints, leading to an equilibrium with an inefficiently low level of borrowing. The central bank can preempt this deleveraging cycle through foreign exchange intervention. Intervention is effective due to frictions in private international financial intermediation. Reserve accumulation has ex ante benefits by reducing the risk of a sudden stop, while intervention has ex-post benefits by limiting inefficient deleveraging. But intervention itself faces constraints. When the central bank's stock of reserves is low, even foreign exchange intervention cannot prevent a sudden stop. [ABSTRACT FROM AUTHOR]

Two striking facts about international capital flows in emerging economies motivate this paper: (1) Governments hold large amounts of international reserves, for which they obtain a return lower than their borrowing cost. (2) Purchases of domestic assets by nonresidents and purchases of foreign assets by residents are both procyclical and collapse during crises. We propose a dynamic model of endogenous default that can account for these facts. The government faces a trade-off between the benefits of keeping reserves as a buffer against rollover risk and the cost of having larger gross debt positions. Long-duration bonds, the countercyclical default premium, and sudden stops are important for the quantitative success of the model. [ABSTRACT FROM AUTHOR]

Until recently, the trend in world capital markets has been toward increasing “globalization” Recent events in Latin America and Asia have forced a rethinking of the desirability of unrestricted world capital flows. In this paper we ask whether simple restrictions on capital mobility can succeed in reducing the volatility of funds flows, whether such restrictions are consistent with the long-term development of the countries that might impose them, whether such restrictions are beneficial for poorer countries while harming wealthier countries, and whether harriers to capital movements should he reduced in magnitude as the development process proceeds. We find first that appropriately selected barriers to capital movements can be used by a poorer country to eliminate the short-term volatility of capital flows and other economic volatility as well. Second, we find that these harriers are consistent with increased rather than reduced levels of economic development in both the short and long run. Third, we show that it is empirically plausible that such barriers will be reduced over time as economies develop. Fourth, we show that, in the long run, all countries can benefit from the presence of barriers to capital mobility. And, fifth, we show that barriers to capital mobility can increase the magnitude of net capital flows in a steady state. [ABSTRACT FROM AUTHOR]

Are unregulated capital flows excessive during a stagflation episode? We argue that they likely are, owing to a macroeconomic externality operating through the economy's supply side. Inflows raise domestic wages through a wealth effect on labor supply and cause unwelcome upward pressure on marginal costs in countries where monetary policy is trying to drive down costs to stabilize inflation. Yet, market forces are likely to generate such inflows. Optimal capital flow management instead requires net outflows, suggesting topsy-turvy capital flows following markup shocks. [ABSTRACT FROM AUTHOR]

We analyze the relationships between bubbles, capital flows, and economic activities in a rational bubble model with two large open economies. We establish a reinforcing relationship between global imbalances and bubbles. Capital flows from South to North facilitate the emergence and the size of bubbles in the North. Bubbles in the North in turn facilitate South-to-North capital flows. The model can simultaneously explain several stylized features of recent bubble episodes. [ABSTRACT FROM AUTHOR]

We provide a simple framework to study the prudential use of capital controls and currency reserves that have been explored in the recent literature. We cover the role of both pecuniary externalities and aggregate demand externalities. The model features a central policy dilemma for emerging economies facing large capital outflows: the choice between increasing the policy rate to stabilize the exchange rate and decreasing the policy rate to stabilize employment. Ex ante capital controls and reserve accumulation can help mitigate this dilemma. We use our framework to survey the recent literature and provide an overview of recent empirical findings on the use of these policies. [ABSTRACT FROM AUTHOR]

We present a simple open economy framework to study the transmission channels of monetary and macroprudential policies and evaluate the implications for international spillovers and global welfare. Using an analytical decomposition, we first identify three transmission channels: intertemporal substitution, expenditure switching, and aggregate income. Quantitatively, expenditure switching plays a prominent role for monetary policy, while macroprudential policy operates almost entirely through intertemporal substitution. Turning to the normative analysis, we show that the risk of a liquidity trap generates a monetary policy tradeoff between stabilizing output today and reducing capital flows to lower the likelihood of a future recession. However, leaning against the wind is not necessarily optimal, even in the absence of capital controls. Finally, we argue that contrary to emerging policy concerns, capital controls are not beggar-thy-neighbor and can enhance global macroeconomic stability. [ABSTRACT FROM AUTHOR]

Following the introduction of the euro in 1999, countries in the South experienced large capital inflows and low productivity. We use data for manufacturing firms in Spain to document a significant increase in the dispersion of the return to capital across firms, a stable dispersion of the return to labor across firms, and a significant increase in productivity losses from misallocation over time. We develop a model of heterogeneous firms facing financial frictions and investment adjustment costs. The model generates cross-sectional and time-series patterns in size, productivity, capital returns, investment, and debt consistent with those observed in production and balance sheet data. We illustrate how the decline in the real interest rate, often attributed to the euro convergence process, leads to a decline in sectoral total factor productivity as capital inflows are misallocated toward firms that have higher net worth but are not necessarily more productive. We conclude by showing that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway. [ABSTRACT FROM AUTHOR]

The author uses gravity estimates as instrumental variables for trade to test the proposition that countries that trade less with the rest of the world are more vulnerable to sudden stops in capital flows. The author finds that, all else equal, a 10 percentage point increase in the trade-to-gross domestic product (GDP) ratio reduces the probability of a sudden stop by approximately 32 percent. The estimation is motivated by a model that introduces balance sheet effects to a standard small open economy. In the model, the probability of sudden stops is directly related to the temptation of the borrowers to default in the aftermath of real depreciations. Countries that trade less with the rest of the world are more vulnerable to large real depreciations and, consequently, are always more tempted to default and are more prone to sudden stops. The policy implications of the results presented here are unambiguous: Trade protectionism does not shield countries from external shocks to their capital accounts. On the contrary, anything that increases the tradable component of a country's GDP will, ceteris paribus, reduce the vulnerability of that country to sudden stops in capital flows. Without large quantities of trade, capital account openness that leads to indebtedness in foreign currencies is risky and should probably be avoided. [ABSTRACT FROM AUTHOR]

Focuses on the role of repudiation in international capital flows with risk strategic externalities of international borrowing. Verification of centralized and decentralized international debt in the market; Risk accountability of centralized over decentralized capital flows; Aid in the regulation set for international borrowing.

Provides information on a study which developed a model of financial sector illiquidity in an open economy. Definition of illiquidity; Framework of the study; Discussion on debt maturity and capital flows; Policy implications of the model.

Presents a formal analysis of erecting barriers to international capital flows. Differences in per capita gross domestic product across countries; Role of wealthier economies in erecting partial barriers to capital mobility; World capital markets' emphasis on short term volatility; Circumstances which barriers to capital mobility are desirable.

The correlation between capital inflows and outflows has increased substantially over time in a sample of 128 advanced and developing countries. We provide evidence that this is a result of an increase in financial globalization (stock of external assets and liabilities). This dominates the effect of an increase in trade globalization (exports plus imports), which reduces the correlation between capital inflows and outflows. In the context of a two-country model with 14 shocks we show that the theoretical impact of financial and trade globalization on the correlation between capital inflows and outflows is consistent with the data. [ABSTRACT FROM AUTHOR]

Lists articles referred for explaining the poor performance of present value model for current account. 'Uninsured Idiosyncratic Risk and Aggregate Saving,' by S.R. Aiyagari; 'International Real Business Cycles,' by D.K. Backus, P.J. Kehoe and F.E. Kydland; 'Explaining Saving-Investment Correlations,' by M. Baxter and M.J. Crucini.

Presents graphs representing imperfect capital mobility and real business cycle model.