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Financial Integration, Entrepreneurial Risk And Global Dynamics

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Executive Summary

This paper investigates within a two-country, general equilibrium, incomplete-markets model that focuses on the importance of idiosyncratic entrepreneurial 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. The 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 inter-temporal costs and benefits of capital-account liberalization.

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