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Open Capital Account: Concrete Wealth or Paper Wealth

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  • Junning Cai

    (University of Hawaii at Manoa)

  • Byron Gangnes

    (University of Hawaii at Manoa)

Abstract

Empirical evidence shows that capital inflows are often used by developing countries to finance excessive consumption. The existing literature explains these phenomena as resulting from institutional imperfections. In contrast, we argue that they can be fundamental outcomes of open capital account, under which ineffectiveness in using foreign savings for investments tends to result in capital inflows being channeled to consumption through wealth effect. Our analysis shows that, while risk aversion causes low investment elasticity and hence reduces the total benefit of capital account liberalization for society over time, it nevertheless tends to increase the benefit enjoyed by current generations and hence drive consumption booms. We show that the proportion of capital inflows used for financing consumption is negatively correlated with investment elasticity. We show that a positive yet uncertain future productivity shock is likely to cause consumption booms because of sluggish investment reactions. Our analysis shows that, the greater the expected future productivity is; or the greater the uncertainty is; the stronger the consumption booms will be. (JEL F21 F32 F41 F43)

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Bibliographic Info

Paper provided by EconWPA in its series International Finance with number 0401002.

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Length: 36 pages
Date of creation: 14 Jan 2004
Date of revision:
Handle: RePEc:wpa:wuwpif:0401002

Note: Type of Document - pdf; prepared on Win2000; pages: 36; figures: 3
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Web page: http://128.118.178.162

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Keywords: open capital account; wealth effect; consumption boom; investment elasticity;

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References

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  1. Bernanke, Ben S, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 85-106, February.
  2. Andrew B. Abel, 2003. "The Effects of a Baby Boom on Stock Prices and Capital Accumulation in the Presence of Social Security," Econometrica, Econometric Society, vol. 71(2), pages 551-578, March.
  3. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1996. "Inflows of capital to developing countries in the 1990s," MPRA Paper 13707, University Library of Munich, Germany.
  4. Elhanan Helpman & Assaf Razin, 1985. "Exchange Rate Management: Intertemporal Tradoffs," NBER Working Papers 1590, National Bureau of Economic Research, Inc.
  5. Nazmi, Nader, 1997. "Exchange rate-based stabilization in Latin America," World Development, Elsevier, vol. 25(4), pages 519-535, January.
  6. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  7. Junning Cai, 2003. "Fundamental Paper Wealth and Monetary Policy," Macroeconomics 0309001, EconWPA.
  8. Matsuyama, Kiminori, 1987. "Current account dynamics in a finite horizon model," Journal of International Economics, Elsevier, vol. 23(3-4), pages 299-313, November.
  9. Michael Gavin & Ricardo Hausmann & Ernesto Talvi, 1997. "Saving Behavior in Latin America: Overview and Policy Issues," IDB Publications 6427, Inter-American Development Bank.
  10. Calvo, Guillermo A, 1986. "Temporary Stabilization: Predetermined Exchange Rates," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1319-29, December.
  11. Helmut Reisen, 1996. "Net capital inflows: how much to accept, how much to resist?," Proceedings, Federal Reserve Bank of San Francisco, pages 289-321.
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