Retrenchment

Finance

Yield (engineering)

Business

Economics

Archaeology

Political science

International economics

Metallurgy

Materials science

Human capital

Capital flows

Public administration

Market economy

Computer security

Computer science

Financial capital

Monetary economics

Capital formation

Liberalization

Asset (computer security)

Capital (architecture)

History

Journal of Political Economy

We develop a model of gross capital flows and analyze their role in global financial stability. In our model, consistent with the data, when a country experiences asset fire sales, foreign investments exit (fickleness), while domestic investments abroad return home (retrenchment). When countries have symmetric expected returns and financial development, the benefits of retrenchment dominate the costs of fickleness and gross flows increase fire-sale prices. Fickleness, however, creates a coordination problem since it encourages local policy makers to restrict capital inflows. When countries are asymmetric, capital flows are driven by additional mechanisms—reach for safety and reach for yield—that can destabilize the receiving country.

A Model of Fickle Capital Flows and Retrenchment