Journal of Banking & Finance Vol. 131 2021
Cheap but flighty: A theory of safety-seeking capital flows
Abstract
We offer a model of financial intermediaries as safe-asset providers in an international context. Investors from countries exposed to expropriation risk seek to invest in safe-haven countries in order to satisfy a demand for safety. Intermediaries compete for such cheap funding by carving out safe claims, which requires demandable debt. While these safety-seeking inflows allow developed countries to lower their funding cost and expand investment, risk-intolerant investors achieve safety by withdrawing even under minimal residual risk. As a result, safety-seeking inflows into developed countries not only reallocate but also create risk. Early liquidation inefficiently diverts scarce resources from productive uses, so a domestic planner wishes to contain the scale of safety-seeking inflows. A macroprudential regulator imposes a Pigouvian tax on safety-seeking inflows.
- DOI
- 10.1016/j.jbankfin.2021.106211
- Volume
- 131
- Pages
- 106211
- Language
- en
- Sources
- crossref openalex bibtex:phds-export.bib