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Macroeconomic and Welfare Implications of Financial Globalization

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  • Ester Faia

Abstract

It is well documented that since the mid-1980s there has been a surge in capital flows due to an increased integration of world financial markets. Absent limited commitment, the increase in financial linkages should improve risk-sharing opportunities and foster consumption smoothing. However the data show that for several countries financial liberalization leads to enhanced consumption volatility. This fact can be rationalized using a small open economy model where foreign lending to households is constrained by a borrowing limit motivated by limited enforcement. Borrowing is secured by collateral in the form of durable investment whose accumulation is subject to adjustment costs. In this economy an increase in the degree of capital account liberalization increases consumption volatility (even relative to output volatility) as agents are unable to exploit risk-sharing opportunities. In presence of risk-averse agents an increase in financial integration reduces welfare.

Suggested Citation

  • Ester Faia, 2011. "Macroeconomic and Welfare Implications of Financial Globalization," Journal of Applied Economics, Taylor & Francis Journals, vol. 14(1), pages 119-144, May.
    • Handle: RePEc:taf:recsxx:v:14:y:2011:i:1:p:119-144
    DOI: 10.1016/S1514-0326(11)60008-1
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    Cited by:

    1. Yuan, Shenguo & Wu, Zhouheng & Liu, Lanfeng, 2022. "The effects of financial openness and financial efficiency on Chinese macroeconomic volatilities," The North American Journal of Economics and Finance, Elsevier, vol. 63(C).
    2. Kułyk Piotr, 2012. "The imperfections of a credit market in agriculture," Management, Sciendo, vol. 16(1), pages 250-263, May.
    3. Yong Ma & Yiqing Jiang, 2023. "Gradual financial integration and macroeconomic fluctuations in emerging market economies: evidence from China," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 18(2), pages 275-310, April.
    4. Lathaporn Ratanavararak, 2018. "The Impact of Imperfect Financial Integration and Trade on Macroeconomic Volatility and Welfare in Emerging Markets," PIER Discussion Papers 79, Puey Ungphakorn Institute for Economic Research.
    5. Ma, Yong & Jiang, Yiqing & Yao, Chi, 2022. "Trade openness, financial openness, and macroeconomic volatility," Economic Systems, Elsevier, vol. 46(1).

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    JEL classification:

    • F3 - International Economics - - International Finance

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