Capital Account Openness and the Losses from Financial Frictions
AbstractThe goal of this paper is to isolate the role of openness to international financial markets (capital account openness) on the total factor productivity (TFP) effect of financial frictions. To do so, I formulate a model in which individual households are either workers or entrepreneurs, can only save in the form of capital, and entrepreneurs are subject to a collateral constraint. Using this structure, I compare two steady states of a calibrated model numerically: one in which the capital rental rate must clear a domestic capital rental market (closed economy), and one in which that rate is given by the world (small open economy). The model predicts that a small open economy is affected less by financial frictions than a closed economy: for the tightest collateral constraint, TFP in a small open economy is only about 1% lower than in the economy without a collateral constraint, while it is 15% lower in a closed economy. TFP losses in a small open economy reflect factor misallocation among incumbent entrepreneurs (intensive margin), not distortions along entry-exit margin, whereas for a tight financial frictions, there are distortions on both intensive and entry-exit margins in a closed economy. Using macro data, I find that a 1% rise in openness is associated with 0.196% decline in the effect of financial frictions on TFP. Running the same regression on subsamples, I also find that this empirical result mainly comes from a group of low income countries.
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 485.
Date of creation: 2013
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-11-22 (All new papers)
- NEP-DGE-2013-11-22 (Dynamic General Equilibrium)
- NEP-ENT-2013-11-22 (Entrepreneurship)
- NEP-IFN-2013-11-22 (International Finance)
- NEP-OPM-2013-11-22 (Open Economy Macroeconomics)
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