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Adjusting to Capital Account Liberalization

Kosuke Aoki, Gianluca Benigno and Nobuhiro Kiyotaki

No 8087, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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 (search for similar items in EconPapers)
JEL-codes: F32 (search for similar items in EconPapers)
Date: 2010-10
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