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Capital Account Liberalization for a Small, Open Economy

Author

Listed:
  • Andreas Hauskrecht

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

  • Nhan Le

    (Economics Department, Indiana University)

Abstract

We survey the ongoing debate on pros and cons for an early and comprehensive liberalization of capital flows by emerging economies. We examine the main theoretical assumptions that would lead to positive effects on output growth and consumption volatility and reflect them with recent literature on market imperfections and information deficiencies. We find little evidence for a positive effect of free capital flows on economic growth and stability for emerging economies. We apply these main results to Vietnam as an example for an open emerging economy and discuss the main explanatory factors that may lead to negative impacts of an early and premature liberalization of capital flows. For small, open economies, absorption capacity for capital is limited. Excessive capital inflows might cause Dutch disease phenomena and asymmetric information might trigger an inefficient use of capital. In particular, we stress potential negative impacts of capital flows on the currency risk premium. Finally, we argue that for a partly dollarized economy as Vietnam a premature liberalization of capital flows might significantly increase financial sector instability. In conclusion, we emphasize the importance of a prudential sequencing of capital account liberalization and strong domestic institutions such as an independent central bank, proper financial regulation and supervision and macroeconomic stability as necessary pre-conditions.

Suggested Citation

  • Andreas Hauskrecht & Nhan Le, 2005. "Capital Account Liberalization for a Small, Open Economy," Working Papers 2005-13, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
    • Handle: RePEc:iuk:wpaper:2005-13
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    References listed on IDEAS

    as
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    Cited by:

    1. Michael G. Plummer, 2012. "Regional Monitoring of Capital Flows and Coordination of Financial Regulation: Stakes and Options for Asia," Chapters, in: Masahiro Kawai & David G. Mayes & Peter Morgan (ed.), Implications of the Global Financial Crisis for Financial Reform and Regulation in Asia, chapter 8, Edward Elgar Publishing.
    2. Akhand Akhtar Hossain, 2009. "Central Banking and Monetary Policy in the Asia-Pacific," Books, Edward Elgar Publishing, number 12777.
    3. Ramzi, Knani & Asma, Madouri & Chebbi, Ali, 2017. "Growth, fluctuations and macroeconomic policies: Evidence from Arab open economies," Economic Analysis and Policy, Elsevier, vol. 55(C), pages 132-146.
    4. Mohammed Ahmed, Abdullahi, 2019. "China’s Bilateral Currency Swap Agreement: Strategic Move to Foster Political and Financial Hegemony," MPRA Paper 109879, University Library of Munich, Germany, revised 08 Oct 2019.
    5. Ulrich Camen, 2006. "Monetary policy in Vietnam: the case of a transition country," BIS Papers chapters, in: Bank for International Settlements (ed.), Monetary policy in Asia: approaches and implementation, volume 31, pages 232-252, Bank for International Settlements.
    6. Mohammed Ahmed, Abdullahi, 2019. "Financial Development and Central Bank Bilateral Currency Swaps: Is there Trade Effect?," MPRA Paper 109875, University Library of Munich, Germany, revised 05 Aug 2019.
    7. Rodriguez, Cesar M., 2017. "The growth effects of financial openness and exchange rates," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 492-512.
    8. Menon, Jayant, 2009. "Managing Success in Viet Nam: Macroeconomic Consequences of Large Capital Inflows with Limited Policy Tools," Working Papers on Regional Economic Integration 27, Asian Development Bank.

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