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A welfare analysis of capital account liberalization

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  • von Hagen, Jürgen
  • Zhang, Haiping

Abstract

We develop a model of a small open economy with credit market frictions of the Holmstrom-Tirole type 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 ZEI - Center for European Integration Studies, University of Bonn in its series ZEI Working Papers with number B 01-2006.

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Date of creation: 2006
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Handle: RePEc:zbw:zeiwps:b012006

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Related research

Keywords: Capital account liberalization; Capital controls; Financial frictions; Macroeconomic fluctuations; Asset price overshooting;

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References

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  1. Philippe Bacchetta & Eric van Wincoop, 2000. "Capital Flows to Emerging Markets: Liberalization, Overshooting, and Volatility," NBER Chapters, in: Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies, pages 61-98 National Bureau of Economic Research, Inc.
  2. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  3. Jürgen von Hagen & Haiping Zhang, 2006. "Financial Liberalization in a Small Open Economy," CESifo Working Paper Series 1771, CESifo Group Munich.
  4. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
  5. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," NBER Technical Working Papers 0282, National Bureau of Economic Research, Inc.
  6. Das, Mitali & Mohapatra, Sanket, 2003. "Income inequality: the aftermath of stock market liberalization in emerging markets," Journal of Empirical Finance, Elsevier, vol. 10(1-2), pages 217-248, February.
  7. Bengt Holmstrom & Jean Tirole, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," Working papers 95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Daron Acemoglu, 2000. "Credit Market Imperfections and Persistent Unemployment," NBER Working Papers 7938, National Bureau of Economic Research, Inc.
  9. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
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Cited by:
  1. Cakici, S. Meral, 2012. "Technology shocks under varying degrees of financial openness," International Review of Economics & Finance, Elsevier, vol. 21(1), pages 232-245.
  2. Jurgen von Hagen & Haiping Zhang, 2007. "Financial Development and International Capital Flows," Macroeconomics Working Papers 22434, East Asian Bureau of Economic Research.
  3. Cakici, S. Meral, 2011. "Financial integration and business cycles in a small open economy," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1280-1302.

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