A sudden stop in those inflows—particularly if accompanied by capital flight, where a country’s own residents move their assets abroad—results in a crisis that forces an abrupt contraction of domestic spending.6 Inflows of capital are often associated with a buildup of financial system vulnerabilities, which can have important consequences for financial stability.
This is particularly the case where the domestic financial system is lacking the ability to efficiently intermediate large gross flows. To the extent that there are weaknesses in a country’s financial system, opening the capital account can feed those weaknesses and result in a larger buildup of imbalances.