Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/39551
Authors: 
von Hagen, Jürgen
Zhang, Haiping
Year of Publication: 
2006
Series/Report no.: 
ZEI working paper B 01-2006
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.
Subjects: 
Capital account liberalization
Capital controls
Financial frictions
Macroeconomic fluctuations
Asset price overshooting
JEL: 
E32
E44
F41
Document Type: 
Working Paper

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