ABSTRACT
Advocates of restrictions on international capital mobility tend to view capital flows as a frequently destabilizing exogenous element that complicates the task of economic policymaking. The first view, that capital flows are typically exogenous destabilizing factors, suggests the need for heavy regulation of financial flows. The second, that capital flows are largely rational, endogenous responses to underlying conditions, suggests that policies, rather than market responses, are disruptive. The distinction between exogenous and endogenous factors also suggests an important role that international capital flows can play in helping to generate more stable and efficiency-increasing economic policies. This chapter discusses the economic and political interaction between domestic distortions and capital account liberalization in the framework of a simple model. The economic arguments for liberalizing current account transactions before capital account transactions depend generally on distortions in goods and factor markets, adjustment costs, the need for macroeconomic stabilization, and domestic financial market distortions.
