Working Paper

International Capital Flows: Private Versus Public Flows in Developing and Developed Countries

Abstract: Empirically, net capital inflows are pro-cyclical in developed countries and counter-cyclical in developing countries. That said, private inflows are pro-cyclical and public in flows are counter-cyclical in both groups of countries. The dominance of private (public) in flows in developed (developing) countries drives the difference in total net inflows. We rationalize these patterns using a dynamic stochastic two-sector model of a small open economy facing borrowing constraints. Private agents over-borrow because of the pecuniary externality arising from constraints. The government saves abroad to reduce aggregate debt, making the economy resilient to adverse shocks. Differences in borrowing constraints and shock processes across countries explain the empirical patterns of capital inflows.

Keywords: reserves; pecuniary externality; cyclicality of net capital ows;

JEL Classification: E44; F32; F34; F41;

https://doi.org/10.21033/wp-2020-27

Bibliographic Information

Provider: Federal Reserve Bank of Chicago

Part of Series: Working Paper Series

Publication Date: 2020-11-13

Number: WP-2020-27