DP2071 | Fickle Investors: an Impediment to Growth?

Publication Date

28/02/1999

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Abstract

The aim of this paper is to construct theoretical models which help to shed light on the recent criticisms of volatile investment flows. We do not make any empirical attempt to establish the existence or gauge the importance of the adverse effects of volatile investment flows nor do we make any implicit claims regarding the role of such flows in recent exchange rate crises. Instead we simply assume the existence of fickle outside investors and examine the consequences for the economy in the context of two partial equilibrium endogenous growth models. In our first model, the scale of fickle outside investment funds traces out a mean-variance tradeoff for the growth rate of the economy. In particular, the volatility of these funds dissuades risk averse agents from risky entrepreneural activities. This result opens up the possibility that some regulation of outside investment may increase growth. Our second model involves increasing returns and multiple equilibria. In the context of this model fickle investor behaviour can have very persistent and substantial effects on both output growth and volatility.