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Keywords:

  • Capital flows;
  • financial crisis;
  • speculative bubbles;
  • F32;
  • F34

Abstract

In this paper, I focus on a phenomenon that has not received much attention in the literature, namely that the mere expectation of foreign direct investment (FDI) incentivizes long-maturity investment projects by domestic residents, and a Sudden Stop when expectations are frustrated. Long-maturity investment projects enhance productivity but increase the economy's vulnerability to Sudden Stop. The discussion is framed in a context in which a Sudden Stop follows a surge of capital inflows (Sudden Flood), and FDI is concentrated on ongoing projects. A Sudden Stop episode can trigger a fire sale of long-term assets, output collapse, and welfare redistribution, which is another ignored phenomenon.