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Welfare Implications of Capital Account Liberalization

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  • Ester Faia

    () (Universitat Pompeu Fabra)

Abstract

In recent decades, capital account liberalization in emerging economies has often been followed by a surge in capital inflows, despite the presence of severe informational asymmetries for foreign lenders. Empirical studies have shown that in emerging economies financial liberalization has led to an increase in consumption volatility (also relative to output). I use a small open economy model where foreign lending to households is constrained by an endogenous borrowing limit. Borrowing is secured by collateral in the form of durable investment whose accumulation is subject to adjustment costs. This economy is able to replicate the aforementioned stylized fact in response to various shocks (productivity, foreign demand and government expenditure). I find that financial liberalization reduces welfare since it increases the volatility of consumption and employment.

Suggested Citation

  • Ester Faia, 2007. "Welfare Implications of Capital Account Liberalization," CEIS Research Paper 92, Tor Vergata University, CEIS.
  • Handle: RePEc:rtv:ceisrp:92
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    References listed on IDEAS

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    Cited by:

    1. Massimiliano Pisani, 2011. "Financial Openness and Macroeconomic Instability in Emerging Market Economies," Open Economies Review, Springer, vol. 22(3), pages 501-532, July.

    More about this item

    Keywords

    endogenous borrowing limit; financial liberalization; consumption volatility.;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F1 - International Economics - - Trade

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