The Korean Journal of Economic Studies
Capital Opening and Ramsey Model (Sungkyunkwan University)
Kyungsoo Kim Year 2019Vol. 67No. 1
AbstractThis paper explores the impact of capital opening in a small open economybased on Ramsey model. In the neo-classical framework when the autarkyinterest rate is higher than the foreign interest rate, capital opening triggersimmediate capital inflows in order to exploit an arbitrage opportunity. Theeconomy moves to new saddle point path. Both capital stock and consumptiondiscretely increase. An increase in lifetime income supports such consumptionincrease. Moving to the new saddle path per capita consumption decreases atthe rate of the autarky and foreign interest difference. As consumptiondecreases trade account turns into positive, but current account is negative,always. In steady state external debt grows constantly. When the autarkyinterest rate is lower than the foreign rate, all adjustment processes will be theopposite. The results of this analysis are closer to the pessimism of capitalopening in emerging economies that emphasizes economic imbalances such asexternal account worsening rather than the benefits of capital opening due tocommon sense views such as consumption smoothing. Here, the deficit in thispaper reflects the benefits of capital opening. The current account surplus insome emerging economies is a phenomenon due to the precautionarymotivation of savings in a second best world, which is in line with building upforeign exchange reserves as self-insurance.