Financial Liberalization and Volatility in Emerging Market Economies

Philippe Aghion, Philippe Bacchetta and Abhijit Banerjee

Cahiers de Recherches Economiques du Département d'économie from Université de Lausanne, Faculté des HEC, Département d’économie

Abstract: The recent East Asian crisis has highlighted the relationship between financial development and output volatility. In this essay we develop a simple model of a small open economy producing a tradeable good using a non-tradeable input and where firms access to borrowings and investment depends on current cash flows. We then show, first that macroeconomic volatility only occurs at intermediate levels of financial development; second, that whilst full financial liberalization, including an unrestricted opening to foreign lending, can destabilize an emerging market economy, in contrast output volatility can be avoided if the same economy opens up to foreign direct investment only. We also draw several policy conclusions regarding the adequate responses to financial crises.

Keywords: emerging markets; volatility; financial liberalization (search for similar items in EconPapers)
JEL-codes: E32 F30 F40 (search for similar items in EconPapers)
Pages: 29 pages
Date: 1998-07
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Published in The Asian Financial Crises : Causes, Contagion and Consequences, Cambridge University Press, 1999, pp. 167-190 (published under the wrong title "Capital Markets and the Instability of Open Economies")

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Related works:
Working Paper: Financial Liberalization and Volatility in Emerging Market Economies (1998)
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Persistent link: https://EconPapers.repec.org/RePEc:lau:crdeep:9811

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