Capital Flows, Crises, and Externalities

Abstract

Emerging economies frequently experience episodes of large capital inflows. In the mid-2000s for example, global financial markets were flush with liquidity. Many emerging economies had better short-term growth prospects than advanced countries and became an attractive destination for global investors. Large capital inflows, or ‘capital flow bonanzas’ in the terminology of Reinhart and Reinhart (2008), pushed up real exchange rates and inflated asset prices in the countries affected. The ensuing rise in purchasing power and in the value of domestic assets that could serve as collateral fueled a large increase in indebtedness.

The author would like to thank Julien Bengui, Olivier Jeanne, Nobuhiro Kiyotaki, Marcus Miller, Carmen Reinhart and Joseph Stiglitz as well as participants of the 2011 IEA Meetings for helpful comments and suggestions. For contact information visit www.korinek.com