A Welfare Analysis of Capital Account Liberalization

• Main Authors: von HAGEN, Jürgen, ZHANG, Haiping
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2007
• Subjects: Capital account liberalization; Capital controls; Financial frictions; Macroeconomic; uctuations; Asset price overshooting; International Economics
• Online Access: https://ink.library.smu.edu.sg/soe_research/1076; https://ink.library.smu.edu.sg/context/soe_research/article/2075/viewcontent/Welfare_Zhang.pdf
• Institution: Singapore Management University

We develop a model of a small open economy with credit market frictions to analyze the consequences of capital account liberalization. We show that nancial opening facilitates the in ows of cheap foreign funds and improves production e ciency. Reforms increasing labor market exibility can further improve such e ciency gains. However, capital account liberalization also has important distributional consequences. Speci cally, it may be impossible to use public transfers to fully compensate the loss of those negatively a ected by capital account liberalization. This explains why nancial opening often meets erce opposition even though it leads to e ciency gains for the economy as a whole. From a practical perspective, capital controls should be lifted gradually for a smooth transition.