Financial liberalization, low world interest rates and global imbalances: a note with a simple two-country model

Abstract

We can understand the role of the liberalization of capital outflows on the global imbalances, the increasing share of US equities in foreign investors’ portfolio and the decline in the world interest rate and the S&P dividend–price ratio, facts observed during the last three decades, when taxes on international asset holdings are reduced in a simple two-country model with costs of portfolio adjustment.

Keywords:

• financial liberalization
• globalization
• global imbalances
• world interest rate
• S&P dividend–price ratio

JEL Classification:

• F30
• F34
• F36

Acknowledgements

I am grateful to Roy Boyd, Charles Engel, and Patricia Toledo for their useful suggestions and comments. All errors are mine.

Notes

¹ Important contributions related to our work are Caballero et al. (2008) and Mendoza et al. (2009). We aim to complement the literature by providing a much simpler and tractable model and emphasizing the link between financial integration and all of the facts mentioned before.

² Greenwood and Kimbrough (1985) and Adams and Greenwood (1985) show that the implications of quantity-based capital controls and taxes on capital flows are theoretically equivalent.

³ See IMF (2012) for other international experiences in the use of controls to manage capital outflows.

⁴ Convex adjustment costs have been extensively used in economics as a device to capture firing and hiring costs, investment adjustment costs and price rigidities. In particular, convex adjustment costs of portfolio have also been used to model monitoring or administrative costs associated with international lending (Chakraborty and Dekle, 2009), and to obtain a well-defined steady-state equilibrium (Bodenstein, 2011).