Capital Flows and the Twin Crises: The Role of Liquidity
IMF Working Papers, July 1, 1997
Source details
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- Capital Flows and the Twin Crises: The Role of Liquidity
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Bibliographic details
- Authors: Ilan Goldfajn, Rodrigo O. Valdes
- Published: July 1, 1997
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451850987.001
Summary / Key findings
- The paper develops a model focusing on the interaction of liquidity creation by financial intermediaries with capital flows and exchange rate collapses.
- Intermediaries’ role of transforming maturities results in larger movements of capital and a higher probability of crisis.
- The model reproduces the observed cycle in capital flows: large inflows, crisis, and abrupt outflows.
- Adverse productivity and international interest rate shocks may trigger a sudden outflow of capital and an exchange collapse.
- The initial shock is magnified by the behavior of individual foreign investors linked through their deposits in the intermediaries.
- The expectation of an eventual exchange rate crisis further links investors’ behavior and amplifies capital flow movements.
Model mechanisms
- Liquidity creation by financial intermediaries, specifically maturity transformation, is central to generating amplified capital movements.
- Linkages among foreign investors—mediated by deposits in intermediaries—create channels through which individual behavior aggregates into systemic outcomes.
- Expectations of an exchange rate crisis create feedback that increases the probability and severity of abrupt capital outflows and exchange collapses.
Subjects and keywords
- Subjects: Capital flows, Capital inflows, Capital outflows, Exchange rates, Liquidity
- Keywords: exchange rate, mover accent, WP
Content in this bundle
- Capital Flows and the Twin Crises: The Role of Liquidity-WP/97/87