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CEP Discussion Paper
Adjusting to Capital Account Liberalization
Kosuke Aoki, Gianluca Benigno and Nobuhiro Kiyotaki
October 2010
Paper No' CEPDP1014:
Full Paper (pdf)

JEL Classification: F32

Tags: credit frictions; capital account liberalization

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.