Rethinking the Effects of Financial Liberalization

53 Pages Posted: 18 Jan 2011

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)

Multiple version iconThere are 3 versions of this paper

Date Written: December 2010

Abstract

During the last few decades, many emerging markets have lifted restrictions on cross-border financial transactions. The conventional view was that this would allow these countries to: (i) receive capital inflows from advanced countries that would finance higher investment and growth; (ii) insure against aggregate shocks and reduce consumption volatility; and (iii) accelerate the development of domestic financial markets and achieve a more efficient domestic allocation of capital and better sharing of individual risks. However, the evidence suggests that this conventional view was wrong. In this paper, we present a simple model that can account for the observed effects of financial liberalization. The model emphasizes the role of imperfect enforcement of domestic debts and the interactions between domestic and international financial transactions. In the model, financial liberalization might lead to different outcomes: (i) domestic capital flight and ambiguous effects on net capital flows, investment, and growth; (ii) large capital inflows and higher investment and growth; or (iii) volatile capital flows and unstable domestic financial markets. The model shows how these outcomes depend on the level of development, the depth of domestic financial markets, and the quality of institutions.

Keywords: capital flows, economic growth, enforcement, financial liberalization, sovereign risk

JEL Classification: F34, F36, F43, G15, O19, O43

Suggested Citation

Broner, Fernando and Ventura, Jaume, Rethinking the Effects of Financial Liberalization (December 2010). CEPR Discussion Paper No. DP8171, Available at SSRN: https://ssrn.com/abstract=1742696

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

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