Capital flows under moral hazard

Viktor Tsyrennikov

Journal of Monetary Economics, 2013, vol. 60, issue 1, 92-108

Abstract: I analyze a model with moral hazard and limited enforcement in a small open economy. I find that when state contingent contracting is allowed adding the moral hazard friction improves the model's predictions along several dimensions. First, it justifies why non-contingent debt is an optimal way to finance an emerging economy. Second, it explains the limited consumption risk-sharing and high, volatile and counter-cyclical interest rates. Third, it generates realistic crisis-like dynamics in which capital inflows are brought to a halt and interest rates sky-rocket. The model also has a strong internal propagation mechanism.

Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:60:y:2013:i:1:p:92-108

DOI: 10.1016/j.jmoneco.2012.11.006

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