The micro and macro dynamics of capital flows

Felipe Saffie, Liliana Varela and Kei-Mu Yi

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We study empirically and theoretically the effects of international financial flows on resource allocation. Using the universe of firms in Hungary, we show that removing capital controls lowers firms’ cost of capital and increases household consumption, with the latter playing a dominant role. The consumption channel leads to reallocation of resources toward high ex penditure elasticity activities—such as services—promoting both the expansion of incumbents and firm entry. A multi-sector heterogeneous firm model replicates these dynamics. Our model shows that non-homotheticity in consumption can quantitatively account for the reallocation of resources towards services and successfully replicates the dynamics of aggregate productivity following episodes of financial openness.

Keywords: firm dynamics; financial liberalization; reallocation; capital flows; TFP; non-homothetic preferences (search for similar items in EconPapers)
JEL-codes: F14 F41 (search for similar items in EconPapers)
Date: 2026-07-08
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Published in Review of Economic Studies, 8, July, 2026. ISSN: 0034-6527

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