Volatile capital flows and financial integration: The role of moral hazard

Tomoo Kikuchi, John Stachurski, George Vachadze

Research output: Contribution to journalArticlepeer-review

1 Citation (Scopus)

Abstract

We study a model in which income and capital flows between countries are jointly determined in a world economy with integrated financial markets. In a setting that combines risky entrepreneurial activity with moral hazard, we find that a shift from autarky to financial integration leads to boom-bust cycles in capital flows, output and consumption. Moral hazard causes cycles because financial intermediaries incentivize effort by insisting entrepreneurs take an equity share in their own projects. The size of this stake rises with wealth, discouraging entrepreneurship and inhibiting capital formation. The reverse is true when wealth falls, generating cycles.

Original languageEnglish
Pages (from-to)170-192
Number of pages23
JournalJournal of Economic Theory
Volume176
DOIs
Publication statusPublished - 2018 Jul
Externally publishedYes

Keywords

  • Capital flows
  • Cycles
  • Financial integration
  • Moral hazard

ASJC Scopus subject areas

  • Economics and Econometrics

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