Balance of Payment Crises In Emerging Markets: Large Capital Inflows and Sovereign Governments

Abstract

The paper shows that the combination of large capital inflows and sovereign governments could give rise to self-fulfilling balance of payments crises. It argues that a current account deficit could impair the resolution of such crises, but the crises themselves could occur even though the current account was in balance. The key is a weak financial sector, possibly made so by an accommodating central bank. In contrast with most of the literature on this subject, the paper endogenizes output and discusses the channels (New Classical and Keynesian) through which a BOP crisis can result in output collapse. Building on a Time to Build model, the paper shows that a growth slowdown can take place even though a BOP crisis brings about no current account reversal.