This is because the application of market discipline, when it comes, is often imperfect. Credit risk premia tend not to increase in a continuous way that leads endogenously to better fiscal and economic policies, but are instead nonlinear.13 Credit risk is under-priced in good times when risk aversion is low, and then rapidly repriced in bad times when risk aversion spikes.
Capital inflows have been even greater when domestic economic growth in the receiving countries has accelerated, and when low interest rates in the sending countries has encouraged lenders to reach for higher yields. The inflows, in turn, have either contributed to inflationary pressures (when there is a fixed exchange rate) or led to currency appreciation (when the exchange rate regime is more flexible).