Global financial cycle and liquidity management

We use a tractable model to show that emerging markets can protect themselves from the global financial cycle by expanding (rather than restricting) capital flows. This involves accumulating foreign liquid assets when liquidity is high then buy back domestic at discount conditions tighten. Since private sector does not internalize how this buffering mechanism reduces international borrowing costs, social planner increases size of flows relative laissez-faire equilibrium. The also shows exchange interventions may be preferable controls in less financially developed countries.