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A welfare analysis of capital account liberalization

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  • von Hagen, Jürgen
  • Zhang, Haiping

Abstract

We develop a model of a small open economy with credit market frictions of the Holmstrom-Tirole type to analyze the consequences of capital account liberalization. We show that financial opening facilitates the inflows of cheap foreign funds and improves production efficiency. Reforms increasing labor market flexibility can further improve such efficiency gains. However, capital account liberalization also has important distributional consequences. Specifically, it may be impossible to use public transfers to fully compensate the loss of those negatively affected by capital account liberalization. This explains why financial opening often meets fierce opposition even though it leads to efficiency gains for the economy as a whole. From a practical perspective, capital controls should be lifted gradually for a smooth transition.

Suggested Citation

  • von Hagen, Jürgen & Zhang, Haiping, 2006. "A welfare analysis of capital account liberalization," ZEI Working Papers B 01-2006, University of Bonn, ZEI - Center for European Integration Studies.
  • Handle: RePEc:zbw:zeiwps:b012006
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    References listed on IDEAS

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    Cited by:

    1. Pierre-Richard Agénor, 2015. "L’intégration financière internationale : Théories, évidences, et leçons des expériences récentes [International financial integration: Theory, evidence and lessons from recent experiences]," Research papers & Policy papers 1508, OCP Policy Center.
    2. Haiping Zhang & Jurgen von Hagen, 2007. "Financial Development and International Capital Flows," Working Papers 16-2007, Singapore Management University, School of Economics.
    3. Cakici, S. Meral, 2011. "Financial integration and business cycles in a small open economy," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1280-1302.
    4. Cakici, S. Meral, 2012. "Technology shocks under varying degrees of financial openness," International Review of Economics & Finance, Elsevier, vol. 21(1), pages 232-245.

    More about this item

    Keywords

    Capital account liberalization; Capital controls; Financial frictions; Macroeconomic fluctuations; Asset price overshooting;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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