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On the Welfare Implications of Financial Globalization without Financial Development

In: NBER International Seminar on Macroeconomics 2007

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  • Enrique G. Mendoza
  • Vincenzo Quadrini
  • José-Víctor Ríos-Rull

Abstract

It is widely argued that countries can reap large gains from liberalizing their capital accounts if financial globalization is accompanied by the development of domestic institutions and financial markets. However, if liberalization does not lead to financial development, globalization can result in adverse effects on social welfare and the distribution of wealth. We use a multi-country model with non-insurable idiosyncratic risk to show that, if countries differ in the degree of asset market incompleteness, financial globalization hurts the poor in countries with less developed financial markets. This is because in these countries liberalization leads to an increase in the cost of borrowing, which is harmful for those heavily leveraged, i.e. the poor. Quantitative analysis shows that the welfare effects are sizable and may justify policy intervention.

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This chapter was published in:

  • Richard Clarida & Francesco Giavazzi, 2009. "NBER International Seminar on Macroeconomics 2007," NBER Books, National Bureau of Economic Research, Inc, number clar07-1.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 3012.

    Handle: RePEc:nbr:nberch:3012

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    1. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
    2. Debreu,Gerard Introduction by-Name:Hildenbrand,Werner, 1986. "Mathematical Economics," Cambridge Books, Cambridge University Press, number 9780521335614, October.
    3. Pierre-Olivier Gourinchas & Olivier Jeanne, 2006. "The Elusive Gains from International Financial Integration," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 715-741.
    4. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," Econometrica, Econometric Society, vol. 68(5), pages 1151-1180, September.
    5. Patrick J. Kehoe & Fabrizio Perri, 2000. "International business cycles with endogenous incomplete markets," Staff Report 265, Federal Reserve Bank of Minneapolis.
    6. Christopher D. Carroll, 1996. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," NBER Working Papers 5788, National Bureau of Economic Research, Inc.
    7. Enrique G. Mendoza, 1991. "Capital Controls and the Gains from Trade in a Business Cycle Model of a Small Open Economy," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 480-505, September.
    8. Quadrini, Vincenzo, 2005. "Policy commitment and the welfare gains from capital market liberalization," European Economic Review, Elsevier, vol. 49(8), pages 1927-1951, November.
    9. Enrique G. Mendoza & Linda L. Tesar, 1995. "Supply-side economics in a global economy," International Finance Discussion Papers 507, Board of Governors of the Federal Reserve System (U.S.).
    10. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991. "International real business cycles," Staff Report 146, Federal Reserve Bank of Minneapolis.
    11. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
    12. Baxter, M. & Crucini, M.J., 1990. "Explaining Saving/Investment Correlation," RCER Working Papers 224, University of Rochester - Center for Economic Research (RCER).
    13. Enrique G. Mendoza, 2007. "Financial Integration, Financial Deepness and Global Imbalance," 2007 Meeting Papers 746, Society for Economic Dynamics.
    14. Mendoza, Enrique G & Tesar, Linda L, 1998. "The International Ramifications of Tax Reforms: Supply-Side Economics in a Global Economy," American Economic Review, American Economic Association, vol. 88(1), pages 226-45, March.
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