COSTLY MONITORING IN FINANCIAL MARKETS AND CAPITAL OUTFLOW RESTRICTIONS

This paper examines welfare implications of removing capital outflow restrictions in a country whose financial markets are relatively inefficient in monitoring borrowers. A simple general equilibrium model is developed in which credit is rationed in one of the two production sectors due to costly information in financial markets. Opening to international capital markets is shown to cause an outflow of domestic wealth but no inflow of foreign credit, leading to more severe credit rationing. If the domestic investment opportunities that are unexploited due to credit rationing are sufficiently profitable, welfare of the country declines after it removes capital outflow restrictions. [O16] 1