Working Paper: CEPR ID: DP8087
Authors: Kosuke Aoki; Gianluca Benigno; Nobuhiro Kiyotaki
Abstract: We study theoretically how the adjustment to liberalization of international financial transaction depends upon the degree of domestic financial development. Using a model with domestic and international borrowing constraints, we show that, when the domestic financial system is underdeveloped, capital account liberalization is not necessarily beneficial because TFP stagnates in the long-run or employment decreases in the short-run. Government policy, including allowing foreign direct investment, can mitigate the possible loss of employment, but cannot eliminate it unless the domestic financial system is improved.
Keywords: capital account liberalization; credit frictions; domestic financial markets
JEL Codes: F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Underdeveloped domestic financial system (F65) | TFP stagnation (F16) |
| Underdeveloped domestic financial system (F65) | Employment decrease (J63) |
| Domestic financial development (O16) | Capital account liberalization outcomes (F32) |
| Government policies (e.g., FDI) (F23) | Mitigation of employment losses (J65) |
| Quality of domestic financial institutions (G21) | TFP (F16) |
| Quality of domestic financial institutions (G21) | Employment (J68) |
| Wage suppression vs interest rate suppression (E49) | Adjustment process (F32) |
| Domestic financial system development vs international context (F30) | Nature of capital inflows (F21) |