Fickle investors: an impediment to growth

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 exisitence or gauge the importance of the adverse affects of flows in recent exchange rate crises. Instead we simply assume the existence of fickle outside investors and examnine 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 meanvariance tradeoff for the growth rate of the economy. In particular, the volatility of these funds dissuades risk averse agents from the risky entrpreneural activities. This result opens up the possibility theat 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