Comments on Korinek’s “Regulating International Capital Flows”

Comments on Korinek’s “Regulating International Capital Flows” Eric Fisher, Cal Poly efisher@calpoly.edu

Externalities? • Is there a negative macroeconomic externality having to do with inflows of financial capital? • Two kinds of capital inflows • Foreign Direct Investment • Short-term dollar-denominated debt • Korinek calls this negative externality a “financial accelerator mechanism”

The Model, Part I • Two periods and two goods: traded and not traded • Endowments

The Model, Part II • There is an initial level of wealth • There is a borrowing constraint that depends on the first period endowment. • The agent chooses a consumption path for traded goods to maximize utility subject to the inter-temporal budget constraint and the borrowing constraint

World Capital Markets • R = 1/β • World real interest rates do not depend upon the endowment shock • The real exchange rate is the relative price f traded goods. • The real exchange rate

Equilibrium • The marginal rate of substitution between traded and not traded goods is the real exchange rate • The marginal rate of substitution between traded goods in the first and second period is an Euler equation that includes the shadow value of the borrowing constraint

Clower Constraint

Understanding the “financial accelerator mechanism” • Since the borrowing constraint depends upon the state of nature, a negative shock to the first-period endowment has two effects: • It lowers real income • It makes the cash-in-advance constraint tighter

Social Planner • The social planner recognizes that the borrowing constraint becomes tighter when the real exchange rate depreciates

New Model and a Result • An important new twist is introduced most of the way through the paper • Now there is a period 0 • In period 0, the local agents can insure against idiosyncratic risk • If contracts are priced fairly, then there is no terms of trade variability in period 1.

Aggregate risk • Now the solutions to the planner’s problem and the private agent’s problem differ. • The private agent is too stupid to figure out about the fact that the cash in advance constraint depends upon the state of the world. • I think there is a problem with the notion of rational expectations here.

Social Pricing Kernel • The shadow value of income in state ω ought to include the marginal effect of the cash-in-advance constraint. • The planner would tax foreign borrowing in states where the marginal utility of income is high. • There is loose dicussion about different nominal instruments

Fascination with a Tobin Tax?

Re-inventing the wheel? • On the Efficiency of a Monetary Equilibrium • Jean-Michel Grandmont and Yves Younes The Review of Economic Studies, Vol. 40, No. 2 (Apr., 1973), pp. 149-165

Reality check • First there is a terms of trade shock • Then the cash in advance constraint becomes even tighter • This makes the real exchange rate depreciate even more • Does this sequence of events really make sense? • Thai bhat had something to do with the terms of trade in Korea in 1997?

Bhat per dollar

Conclusion • Simple model. That’s good and bad. • Any empirical analysis would hinge upon the exact specification of the endogenous Clower constraint. • Is this really what a financial crisis is all about?

Comments on Korinek’s “Regulating International Capital Flows”