When Liberal Policies Reflect External Shocks, What Do We Learn?

Leonardo Bartolini and Allan Drazen , Journal of International Economics 42(3-4) , 249-273 , May 1997.

We present a model where policies of free capital mobility can signal governments' future policies, but the informativeness of the signal depends on the path of world interest rates. Capital flows to "emerging markets" reflect investors' perception of these markets' political risk. With low world interest rates, emerging markets experience a capital inflow and engage in a widespread policy of free capital mobility, whereas others impose controls to trap capital onshore, thus signaling future policies affecting capital mobility. These predictions are consistent with the recent experience of capital flows and policies affecting capital mobility in developing countries.

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