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Financial integration, entrepreneurial risk and global dynamics

  • Vasia Panousi
  • George-Marios Angeletos

How does financial integration impact capital accumulation, current-account dynamics, and cross-country inequality? This paper investigates this question within a two-country, general-equilibrium, incomplete-markets model that focuses on the importance of idiosyncratic entrepreneurial risk---a risk that introduces, not only a precautionary motive for saving, but also a wedge between the interest rate and the marginal product of capital. Our contribution is then to show that this friction provides a simple explanation for the emergence of global imbalances, a simple resolution to the empirical puzzle that capital often fails to flow from the rich or slow-growing countries to the poor or fast-growing ones, and a distinct set of policy lessons regarding the intertemporal costs and benefits of capital-account liberalization.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2010-54.

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Date of creation: 2010
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Handle: RePEc:fip:fedgfe:2010-54
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