Financial integration, entrepreneurial risk and global dynamics

The MIT Faculty has made this article openly available. Please share how this access benefits you. Your story matters. Abstract How does financial integration impact capital accumulation, current-account dynamics, and crosscountry inequality? This paper investigates this question within a two-country, general-equilibrium, incomplete-markets model that focuses on the importance of idiosyncratic en-trepreneurial risk—a risk that introduces, not only a precautionary motive for saving, but also a wedge between the interest rate and the marginal product of capital. Our contribution is then to show that this friction provides a simple explanation for the emergence of global imbalances, a simple resolution to the empirical puzzle that capital often fails to flow from the rich or slow-growing countries to the poor or fast-growing ones, and a distinct set of policy lessons regarding the intertemporal costs and benefits of capital-account liberalization. for useful comments and discussions. Finally, we are particularly grateful to Dean Corbae and Ramon Marimon for encouraging us to write this paper. The views presented in this paper are solely those of the authors and do not necessarily represent those of the Board of Governors of the Federal Reserve System or its staff members.