Welfare Implications of Capital Account Liberalization

Ester Faia

CEIS Research Paper from Tor Vergata University, CEIS

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.

Keywords: endogenous borrowing limit; financial liberalization; consumption volatility. (search for similar items in EconPapers)
JEL-codes: E52 F1 (search for similar items in EconPapers)
Pages: 26
Date: 2007-02-20
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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Citations: View citations in EconPapers (1)

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