Rethinking the Effects of Financial Liberalization

25 Pages Posted: 7 Apr 2009

See all articles by Fernando Broner

Fernando Broner

CREI; Barcelona GSE; Universitat Pompeu Fabra; CEPR

Jaume Ventura

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: October 7, 2008

Abstract

During the last few decades, emerging markets have lifted most restrictions on international asset trade. The conventional view was that (i) capital would flow into these countries raising investment and growth; (ii) these countries would use international capital markets to smooth productivity, terms-of-trade, and other shocks and achieve less volatile consumption; and (iii) financial integration would encourage the development of domestic financial markets, leading to a more efficient domestic allocation of capital and better sharing of individual risks. But in those emerging markets that liberalized their financial markets, average net capital flows have been small and even negative, volatile and procyclical. As a result, (i) investment and growth have not only not increased but even declined in some cases; (ii) consumption has become more volatile; and (iii) domestic financial markets have become unstable and prone to crises. In this paper, we present a simple model of financial liberalization that can account for these observations. The key friction in the model is sovereign risk. What makes this model different from previous models of sovereign risk is the existence of gains from domestic asset trade and that governments cannot discriminate between domestic and foreign creditors when enforcing debt payments. This makes the theory more realistic both in terms of assumptions and results.

Keywords: Financial liberalization, sovereign risk, enforcement, capital flows

JEL Classification: F34, F36, G15

Suggested Citation

Broner, Fernando and Ventura, Jaume, Rethinking the Effects of Financial Liberalization (October 7, 2008). Available at SSRN: https://ssrn.com/abstract=1374231 or http://dx.doi.org/10.2139/ssrn.1374231

Fernando Broner (Contact Author)

CREI ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

HOME PAGE: http://www.crei.cat/people/broner

Barcelona GSE

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

HOME PAGE: http://www.crei.cat/people/broner

CEPR ( email )

London
United Kingdom
+34 93 542 2601 (Phone)

Jaume Ventura

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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