TY  - JOUR
AU  - Aghion,Philippe
AU  - Bacchetta,Philippe
AU  - Banerjee,Abhijit
TI  - Financial Development and the Instability of Open Economies
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 10246
PY  - 2004
Y2  - January 2004
UR  - http://www.nber.org/papers/w10246
L1  - http://www.nber.org/papers/w10246.pdf
N1  - Author contact info:
Philippe Aghion
Department of Economics
Harvard University
1805 Cambridge St
Cambridge, MA 02138
Tel: 617/495-6675
Fax: 617/495-4341
E-Mail: paghion@fas.harvard.edu

Philippe Bacchetta
Faculty of Business and Economics
University of Lausanne
Extranef
CH-1015 Lausanne
Switzerland
E-Mail: philippe.bacchetta@unil.ch

Abhijit Banerjee
MIT
Department of Economics
E52-252d
50 Memorial Drive
Cambridge, MA 02142-1347
Tel: 617/253-8855
Fax: 617/253-1330
E-Mail: banerjee@mit.edu
AB  - This paper introduces a framework for analyzing the role of financial factors as a source of instability in small open economies. Our basic model is a dynamic open economy model with a tradeable good produced with capital and a country-specific factor. We also assume that firms face credit constraints, with the constraint being tighter at a lower level of financial development. A basic implication of this model is that economies at an intermediate level of financial development are more unstable than either very developed or very underdeveloped economies. This is true both in the sense that temporary shocks have large and persistent effects and also in the sense that these economies can exhibit cycles. Thus, countries that are going through a phase of financial development may become more unstable in the short run. Similarly, full capital account liberalization may destabilize the economy in economies at an intermediate level of financial development: phases of growth with capital inflows are followed by collapse with capital outflows. On the other hand, foreign direct investment does not destabilize.
ER  -