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Financial Integration and Capital Accumulation

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  • Panousi, Vasia

Abstract

How does financial integration impact capital accumulation when countries differ in the efficacy of internal financial markets? We examine this question within a two-country incompletemarkets model featuring a specific financial friction: agents face uninsurable idiosyncratic risk in their investment, or entrepreneurial, opportunities. Under financial autarchy, the South (the country with the least developed risk-sharing possibilities) features a higher precautionary motive for saving and a lower risk-free rate, but also a lower capital stock and lower output. Upon financial integration,capital flies out of the poor, capital-scarce South, causing a prolonged deep in domestic activity. At the same time, the rich, capital-abundant North runs large currentaccount deficits and enjoys a prolong boom. However, these effects are more than reversed in the long run: as time passes, capital starts flowing back into the South, eventually leading to higher domestic activity than under autarchy. Taken together, these results help explain the emergence of global imbalances while also providing a distinct policy lesson regarding the intertemporal costs and benefits of financial integration.

Suggested Citation

  • Panousi, Vasia, 2009. "Financial Integration and Capital Accumulation," MPRA Paper 24238, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:24238
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    More about this item

    Keywords

    Financial integration; capital-account liberalization; incomplete markets; idiosyncratic risk; entrepreneurship; current-account deficits; global imbalances;

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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