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ITF220 Prof.J.Frankel
Welfare gains from The Intertemporal-Optimization Theory
of the Current Account, and Welfare Gains
open capital markets from International Borrowing
ITF220 Prof.J.Frankel
The
THE Intertemporal-Optimization
INTERTEMPORAL-OPTIMIZATION Theory
THEORY of the
OF THE Current
CURRENT Account,
ACCOUNT, AND
WELFARE
and GAINS
Welfare FROM
Gains INTERNATIONAL
from BORROWING
International Borrowing
Welfare is
higher at
=> domestic residents borrow
from abroad, so that they point B.
can consume more in Period 0.
Source: Caves, Frankel & Jones (2007) Chapter 21.5, World Trade & Payments, 10th ed.
ITF220 Prof.J.Frankel
THE INTERTEMPORAL-OPTIMIZATION THEORY Theory
The Intertemporal-Optimization OF THEofCURRENT ACCOUNT,
the Current AND WELFARE
Account,
GAINS
and FROM
Welfare INTERNATIONAL
Gains BORROWING,
from International continued
Borrowing, continued
Shift production
from Period 0 to 1,
and yet consume
more in Period 0,
thanks to foreign
capital flows. Welfare is higher
at point C.
Source: Caves, Frankel & Jones (2007) Chapter 21.5, World Trade &Payments.
Does this theory work in practice?
Effect when countries open their stock markets to foreign investors
on cost of equity capital to domestic firms .
Liberalization occurs in Year 0.
ITF220 Prof.J.Frankel
Does this theory work in practice? continued
Peter Henry
(2007)
ITF220 Prof.J.Frankel
Does this theory
work in practice?
continued
Norway discovered
North Sea oil in 1970s.
It temporarily ran
a large CA deficit,
}
to finance investment
(while the oil fields
were being developed)
& to finance consumption
}
Subsequently,
(as was rational, Norway ran big
since Norwegians knew CA surpluses,
they would be richer > 10% GDP 2000-14.
in the future).
ITF220 Prof.J.Frankel
Indications that financial markets
do not always work so well in practice
ITF220 Prof.J.Frankel
Indications that financial markets do not always work well (continued)
IIF
http://www.iif.com/press/press+406.php
Causes of renewed capital flows
to emerging market countries
in early 1990s, 2003-13
IMF
EM countries used post-2003 inflows
EM countries used post-2003 inflows
to build international reserves
to build foreign exchange reserves
More on
opening equity
markets to
foreign
investment.
ITF220 Prof.J.Frankel
Effect when countries open their stock CAPITAL ACCOUNT LIBERALIZATION: THEORY,
markets to foreign investors EVIDENCE, AND SPECULATION
Peter Blair Henry
on growth. Working Paper 12698
http://www.nber.org/papers/w12698
ITF220 Prof.J.Frankel
Appendix 2: Three cycles of capital flows to EMs
1. 1975-81 -- Recycling of petrodollars, via bank loans
1982, Aug. -- International debt crisis starts in Mexico and spreads
1982-89 -- The lost decade in Latin America.
start
start
3rd boom
(carry trade
stop & BRICs)
(Asia
2nd boom (emerging markets) crisis) start
start
IMF
Capital flowed to Latin America
in the 1990s, and again 2004-12
3rd boom
(carry trade & BRICs)
2nd boom
(emerging markets)
start
start
IMF