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On the Welfare Implications of Financial Globalization without Financial Development

  • Enrique G. Mendoza
  • Vincenzo Quadrini
  • José-Victor Ríos-Rull

It is widely argued that countries can reap large gains from liberalizing their capital accounts if financial globalization is accompanied by the development of domestic institutions and financial markets. However, if liberalization does not lead to financial development, globalization can result in adverse effects on social welfare and the distribution of wealth. We use a multi-country model with non-insurable idiosyncratic risk to show that, if countries differ in the degree of asset market incompleteness, financial globalization hurts the poor in countries with less developed financial markets. This is because in these countries liberalization leads to an increase in the cost of borrowing, which is harmful for those heavily leveraged, i.e. the poor. Quantitative analysis shows that the welfare effects are sizable and may justify policy intervention.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13412.

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Date of creation: Sep 2007
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Publication status: published as On the Welfare Implications of Financial Globalization without Financial Development , Enrique G. Mendoza, Vincenzo Quadrini, José-Víctor Ríos-Rull. in NBER International Seminar on Macroeconomics 2007 , Clarida and Giavazzi. 2008
Handle: RePEc:nbr:nberwo:13412
Note: EFG IFM
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  1. Enrique G. Mendoza, 2007. "Financial Integration, Financial Deepness and Global Imbalance," 2007 Meeting Papers 746, Society for Economic Dynamics.
  2. Patrick J. Kehoe & Fabrizio Perri, 2002. "International Business Cycles with Endogenous Incomplete Markets," Econometrica, Econometric Society, vol. 70(3), pages 907-928, May.
  3. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
  4. Gourinchas, Pierre-Olivier & Jeanne, Olivier, 2003. "The Elusive Gains from International Financial Integration," CEPR Discussion Papers 3902, C.E.P.R. Discussion Papers.
  5. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991. "International real business cycles," Staff Report 146, Federal Reserve Bank of Minneapolis.
  6. Baxter, M. & Crucini, M.J., 1990. "Explaining Saving/Investment Correlation," RCER Working Papers 224, University of Rochester - Center for Economic Research (RCER).
  7. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
  8. Carroll, Christopher D, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, MIT Press, vol. 112(1), pages 1-55, February.
  9. Quadrini, Vincenzo, 2005. "Policy commitment and the welfare gains from capital market liberalization," European Economic Review, Elsevier, vol. 49(8), pages 1927-1951, November.
  10. Enrique G. Mendoza & Linda L. Tesar, 1995. "Supply-side economics in a global economy," International Finance Discussion Papers 507, Board of Governors of the Federal Reserve System (U.S.).
  11. Enrique G. Mendoza, 1991. "Capital Controls and the Gains from Trade in a Business Cycle Model of a Small Open Economy," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 480-505, September.
  12. Mendoza, Enrique G & Tesar, Linda L, 1998. "The International Ramifications of Tax Reforms: Supply-Side Economics in a Global Economy," American Economic Review, American Economic Association, vol. 88(1), pages 226-45, March.
  13. repec:cup:cbooks:9780521335614 is not listed on IDEAS
  14. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
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