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A Welfare Analysis of Capital Liberalization

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  • Jurgen von Hageny

    (SMU)

  • Haiping Zhang

Abstract

We develop a model of a small open economy with credit market frictions to analyze the consequences of capital account liberalization. We show that financial opening facilitates the inflows of cheap foreign funds and improves production efficiency. Reforms increasing labor market flexibility can further improve such efficiency gains. However, capital account liberalization also has important distributional consequences. Specifically, it may be impossible to use public transfers to fully compensate the loss of those negatively affected by capital account liberalization. This explains why financial opening often meets fierce opposition even though it leads to efficiency gains for the economy as a whole. From a practical perspective, capital controls should be lifted gradually for a smooth transition.

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Bibliographic Info

Paper provided by East Asian Bureau of Economic Research in its series Macroeconomics Working Papers with number 22489.

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Date of creation: Jan 2007
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Handle: RePEc:eab:macroe:22489

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Postal: JG Crawford Building #13, Asia Pacific School of Economics and Government, Australian National University, ACT 0200
Web page: http://www.eaber.org
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Related research

Keywords: Capital account liberalization; capital controls; financial frictions;

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  1. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2008. "An Equilibrium Model of "Global Imbalances" and Low Interest Rates," American Economic Review, American Economic Association, vol. 98(1), pages 358-93, March.
  2. Philippe Bacchetta & Eric van Wincoop, 1998. "Capital flows to Emerging Markets: Liberalization, Overshooting, and Volatility," Working Papers 98.01, Swiss National Bank, Study Center Gerzensee.
  3. Mitali Das & Sanket Mohapatra, 2002. "Income inequality: The aftermath of stock market liberalization in emerging markets," Discussion Papers 0102-42, Columbia University, Department of Economics.
  4. Matteo Iacoviello, 2002. "House Prices and Business Cycles in Europe: a VAR Analysis," Boston College Working Papers in Economics 540, Boston College Department of Economics.
  5. Christopher J. Neely, 1999. "An introduction to capital controls," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 13-30.
  6. Caprio,Gerard & Honohan,Patrick & Stiglitz,Joseph E. (ed.), 2006. "Financial Liberalization," Cambridge Books, Cambridge University Press, number 9780521030991, October.
  7. Sebastian Edwards, 2007. "Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences," NBER Books, National Bureau of Economic Research, Inc, number edwa06-1, May.
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