Capital mobility and sudden stops: consequences and policy options

Abstract

This dissertation attempts in three essays to contribute to the growing body of research on the problems associated with sudden stops of capital inflows, known to have been at the heart of many recent emerging market crises. It does this by developing basic models that can incorporate sudden stops and hopefully make policy relevant recommendations. The first essay develops a simple three date representative agent model of a small open endowment economy without money. It allows sudden stops to occur at date two and asks whether individuals in such a shock-prone world are still better off borrowing than in autarky. Unambiguously, this chapter shows that individuals are better off borrowing than in autarky and provides a tractable core model on which the later chapters build. The second essay then includes a long-term borrowing option as well as country-specific risk premia based on an information asymmetry between domestic borrowers and international lenders. This allows analysis of optimal maturity choices in a meaningful way. The intent is to address questions in the literature concerning whether emerging economies could enhance welfare by imposing short-term capital controls to encourage the use of longer-maturing debt and thus avoid the sudden stop. The results imply that short-term capital controls would generally lower welfare, even when sudden stops are fully anticipated. Finally, the third essay extends the horizon of the model and includes a much wider range of maturities. This allows one to start making sense of maturity bunching (when a country's debt all matures around a given date) which is known to exacerbate sudden-stop related problems. The model shows that maturity bunching can occur endogenously when both risk premia and uncertainty over the duration of the sudden stop are present.