International Capital Flows and Aggregate Output

Juergen von Hagen and Haiping Zhang (zhanghaiping2001@yahoo.com)

No 10-2010, Working Papers from Singapore Management University, School of Economics

Abstract: We develop a tractable multi-country overlapping-generations model and show that cross-country differences in financial development explain three recent empirical patterns of international capital flows. Domestic financial frictions in our model distort interest rates and aggregate output in the less financially developed countries. International capital flows help ameliorate the two distortions.International flows of financial capital and foreign direct investment a ect aggregate output in each country directly through affecting the size of aggregate investment. In addition, they affect aggregate output indirectly through affecting the composition of aggregate investment and the size of aggregate savings. Under certain conditions, the indirect effects may dominate the direct effects so that, despite "uphill" net capital flows, full capital mobility may raise the steady-state aggregate output in the poor country as well as raise world output. However, if foreign direct investment is restricted, "uphill" financial capital flows strictly reduce the steady-state aggregate output in the poor countries and it is more likely that the steady-state world output is lower than under international financial autarky.

Keywords: Capital account liberalization; financial frictions; financial development; foreign direct investment; world output gains (search for similar items in EconPapers)
JEL-codes: E44 F41 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2010-05
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn, nep-mac and nep-opm
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Published in SMU Economics and Statistics Working Paper Series

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Related works:
Working Paper: International Capital Flows and Aggregate Output (2011)
Working Paper: International Capital Flows and Aggregate Output (2011)
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