China maintains tight controls over its capital account. Its current policy regime also features financial repression, under which banks are required to extend funds to state-owned enterprises (SOEs) at favorable terms, despite their lower productivity than private firms on average. We incorporate these features into a general equilibrium model. Our model illustrates a tradeoff between aggregate productivity and inter-temporal allocative efficiency from capital account liberalization under financial repression. As a result, along a transition path with a declining SOE share, welfare-maximizing policy calls for rapid removal of financial repression, but gradual liberalization of the capital account.
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Article Citation
Zhang, Jingyi, Mark M. Spiegel, and Zheng Liu. 2018. “Optimal Capital Account Liberalization in China,” Federal Reserve Bank of San Francisco Working Paper 2018-10. Available at https://doi.org/10.24148/wp2018-10