We develop a general equilibrium model with nancial frictions in which internal capital (equity capital) and external capital (bank loans) have different rates of return. Financial development raises the rate of return on external capital but has a non-monotonic effect on the rate of return on...

We develop a model of a small open economy with credit market frictions to analyze the consequences of capital account liberalization. We show that financial opening facilitates the inflows of cheap foreign funds and improves production efficiency. Reforms increasing labor market flexibility can...