DP10502 Cheap but flighty: how global imbalances create financial fragility

Author(s): Toni Ahnert, Enrico C Perotti
Publication Date: March 2015
Keyword(s): absolute safety, capital flows, safe haven, unstable funding
JEL(s): F3, G2
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10502

Can a wealth shift to emerging countries explain instability in developed countries? Investors exposed to political risk seek safety in countries with better property right protection. This induces private intermediaries to offer safety via inexpensive demandable debt, and increases lending into marginal projects. Because safety conscious foreigners escape any risk by running also in some good states, cheap foreign funding leads to larger and more frequent runs. Beyond some scale, foreign runs also induce domestic runs in order to avoid dilution. When excess liquidation causes social losses, a domestic planner may limit the scale of foreign inflows or credit volume.