Endogenous Financial Intermediation and Real Effects of Capital Account Liberalization
41 Pages Posted: 25 May 2002
Date Written: June 2004
We consider lending and investment under asymmetric information in a small, developing economy. We allow different forms of financing contracts to arise endogenously in the credit market. Financial intermediaries mitigate a moral hazard problem in investment choice through costly monitoring and liquidation. We then examine the impact of opening the capital account on both welfare and the structure of lending contracts. Depending on the quality and cost of the monitoring technology, liberalizing the capital account may improve or worsen the efficiency of financial intermediaries, leading to an improvement or worsening of the aggregate composition of investment projects. Efficient financial intermediaries are neither necessary nor sufficient for a capital account liberalization to improve welfare.
Keywords: Financial intermediation, capital account, moral hazard, lending contracts
JEL Classification: G2, F3, O1
Suggested Citation: Suggested Citation