Financial Integration, Entrepreneurial Risk and Global Dynamics
Federal Reserve Board
Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)
October 5, 2010
FEDS Working Paper No. 2010-54
How does financial integration impact capital accumulation, current-account dynamics, and cross-country inequality? This paper investigates this question within a two-country, general-equilibrium, incomplete-markets model that focuses on the importance of idiosyncratic entrepreneurial risk -- a risk that introduces, not only a precautionary motive for saving, but also a wedge between the interest rate and the marginal product of capital. Our contribution is then to show that this friction provides a simple explanation for the emergence of global imbalances, a simple resolution to the empirical puzzle that capital often fails to flow from the rich or slow-growing countries to the poor or fast-growing ones, and a distinct set of policy lessons regarding the intertemporal costs and benefits of capital-account liberalization.
Number of Pages in PDF File: 46
Keywords: Financial integration, capital-account liberalization, incomplete markets, idiosyncratic risk, entrepreneurship, current-account deficits, global imbalances
JEL Classification: E13, F15, F41
Date posted: November 15, 2011
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