DP14893 The Micro and Macro Dynamics of Capital Flows

Author(s): Felipe Saffie, Liliana Varela, Kei-Mu Yi
Publication Date: June 2020
Date Revised: June 2021
Keyword(s): Capital Flows, Financial Liberalization, Firm Dynamics, non homothetic preferences, reallocation, Welfare
JEL(s): F15, F30, F41, F43, F63
Programme Areas: International Macroeconomics and Finance, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14893

We study empirically and theoretically the effects of international capital flows on resource allocation. Using the universe of firms in Hungary, we show that financial openness triggers input-cost and consumption channels, with the latter dominant and reallocating resources toward high expenditure elasticity activities in the short run. A multi-sector heterogeneous firm trade model replicates these dynamics. In the long-run, the model predicts that resources will shift towards manufacturing exports to service debt. Owing to endogenous terms of trade dynamics, countries face a trade-off between the speed of convergence and their long-run capital stock; thus, financial openness can lead to welfare losses.