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Financial Liberalization in a Small Open Economy


  • Jürgen Hagen


  • Haiping Zhang



We address three related questions concerning financial liberalization in a small open economy. Does financial liberalization and the resulting capital inflow improve production efficiency in the domestic economy? Who benefits from financial liberalization in the long run and in the short run? Should financial liberalization be implemented gradually or hastily? Our main results are as follows. First, whether financial deregulation in one sector can improve production efficiency may depend on financial regulation in other sectors. Second, financial liberalization may have opposite welfare implications to domestic agents with different productivity in the long run. Third, although some domestic agents lose in the long run, they actually benefit from financial liberalization during the transitional process of deregulation. Finally, a gradual implementation helps achieve a smooth transition. Copyright Springer Science + Business Media, LLC 2006

Suggested Citation

  • Jürgen Hagen & Haiping Zhang, 2006. "Financial Liberalization in a Small Open Economy," Open Economies Review, Springer, vol. 17(4), pages 373-398, December.
  • Handle: RePEc:kap:openec:v:17:y:2006:i:4:p:373-398
    DOI: 10.1007/s11079-006-0355-9

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    References listed on IDEAS

    1. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
    2. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    3. Aoki, Kosuke & Benigno, Gianluca & Kiyotaki, Nobuhiro, 2010. "Adjusting to Capital Account Liberalization," CEPR Discussion Papers 8087, C.E.P.R. Discussion Papers.
    4. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
    5. Iacoviello, Matteo & Minetti, Raoul, 2006. "International business cycles with domestic and foreign lenders," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 2267-2282, November.
    6. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
    7. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    8. Nobuhiro Kiyotaki & John Moore, 2002. "Liquidity and Asset Pricing," ESE Discussion Papers 116, Edinburgh School of Economics, University of Edinburgh.
    9. René M. Stulz, 2007. "The Limits of Financial Globalization," Journal of Applied Corporate Finance, Morgan Stanley, vol. 19(1), pages 8-15.
    10. Alessandria, George & Qian, Jun, 2005. "Endogenous financial intermediation and real effects of capital account liberalization," Journal of International Economics, Elsevier, vol. 67(1), pages 97-128, September.
    11. Ricardo J. Caballero & Arvind Krishnamurthy, 2003. "Excessive Dollar Debt: Financial Development and Underinsurance," Journal of Finance, American Finance Association, vol. 58(2), pages 867-894, April.
    12. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 647-663.
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    Cited by:

    1. Pierre-Richard Agénor, 2015. "L’intégration financière internationale : Théories, évidences, et leçons des expériences récentes [International financial integration: Theory, evidence and lessons from recent experiences]," Research papers & Policy papers 1508, OCP Policy Center.
    2. von Hagen, Jürgen & Zhang, Haiping, 2008. "Financial frictions, capital reallocation, and aggregate fluctuations," Journal of Economic Dynamics and Control, Elsevier, vol. 32(3), pages 978-999, March.
    3. repec:onb:oenbwp:y::i:141:b:1 is not listed on IDEAS
    4. Jürgen von Hagen & Haiping Zhang, 2008. "A Welfare Analysis of Capital Account Liberalization," Review of International Economics, Wiley Blackwell, vol. 16(3), pages 576-590, August.
    5. Haiping Zhang & Jurgen von Hagen, 2007. "Financial Development and International Capital Flows," Working Papers 16-2007, Singapore Management University, School of Economics.
    6. Kerstin Gerling, 2008. "The Real Consequences of Financial Market Integration when Countries Are Heterogeneous," Working Papers 141, Oesterreichische Nationalbank (Austrian Central Bank).


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