DP15328 Global Financial Cycle and Liquidity Management

Author(s): Olivier Jeanne, Damiano Sandri
Publication Date: September 2020
Keyword(s): capital flow management, capital controls, Capital Flows, Foreign Exchange Reserves, sudden stop
JEL(s): F31, F32, F36, F38
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15328

We use a tractable model to show that emerging markets can protect themselves from the global financial cycle by expanding (rather than restricting) capital flows. This involves accumulating reserves when global liquidity is high to buy back domestic assets at a discount when global financial conditions tighten. Since the private sector does not internalize how this buffering mechanism reduces international borrowing costs, a social planner increases the size of capital flows beyond the laissez-faire equilibrium. The model also provides a role for foreign exchange intervention in less financially developed countries. The main predictions of the model are consistent with the data.