Reach for yield has a bad connotation. It is often associated with investments perceived to be motivated not by the investor's deep conviction or knowledge of the receiving market but by the depressed returns in the investor's natural market. The main concern with investment flows supported by this motivation is that they tend to be fickle and exit at the first sight of trouble in local markets. Nowhere is this concern more prevalent than with the capital inflows experienced by emerging markets (EM) in response to very accommodative monetary policy in developed markets (DM).In Caballero and Simsek (2018) we develop a model of fickle capital flows and show that as long as countries are sufficiently similar, gross capital flows create global liquidity despite their fickleness, but that local policymakers underestimate the value of this global liquidity. However, we also show that when returns are higher in an (infinitesimal) EM country than in other countries, then fickle inflows can be destabilizing. In this paper we follow on the latter lead and analyze the situation of a block of EM economies facing fickle foreign flows.
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