FINANCIAL GLOBALIZATION AND ECONOMIC POLICIES

GLOBAL ECONOMY & DEVELOPMENT

WORKING PAPER 34 | APRIL 2009

FINANCIAL GLOBALIZATION AND

ECONOMIC POLICIES

M. Ayhan Kose

Eswar S. Prasad

Kenneth Rogoff

Shang-Jin Wei

The Brookings Global Economy and Development

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Ayhan Kose is a senior economist in the MacroFinancial Linkages Unit of the International Monetary

Fund��s Research Department.

Eswar Prasad is a Senior Fellow at the Brookings

Institution, the Tolani Senior Professor of Trade Policy

in the department of applied economics and management at Cornell University and a research associate at

the National Bureau of Economic Research.

Kenneth Rogoff is a Professor of Economics at

Harvard University and a Nonresident Senior Fellow at

the Brookings Institution.

Shang-Jin Wei is a Professor of Finance and Economics

and N.T. Wang Professor of Chinese Business and

Economy at the Columbia Business School.

Authors�� note:

This paper is prepared for the Handbook of Development Economics, edited by Dani Rodrik and Mark R.

Rosenzweig. We would like to thank Stijn Claessens, Marco Terrones, and our discussant, Dani Rodrik, for their

detailed suggestions. We also thank conference participants for providing helpful comments at the Handbook

Preconference. Dionysis Kaltis and Yusuke Tateno provided excellent research assistance. The views expressed

in this paper are solely those of the authors and do not necessarily re?ect those of the IMF, IMF policy or the

Brookings Institution.

CONTENTS

Abstract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Financial Globalization: Measurement and Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

How to measure ?nancial integration? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Evolution of ?nancial globalization: some basic stylized facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Factors driving ?nancial globalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Macroeconomic Implications of Financial Globalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Economic growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Macroeconomic volatility and patterns of international risk-sharing . . . . . . . . . . . . . . . . . . . . . 21

Economic Policies and Growth Outcomes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Structural Characteristics and Economic Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Financial sector development. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Institutional quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Trade openness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Macroeconomic Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40

Theory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40

Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40

Monetary and exchange rate policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Direction of Capital Flows and Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Empirical evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

How to interpret these ?ndings? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Are developing countries savings-constrained? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

Policy implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Capital Controls As A Policy Tool . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Implementation and measurement issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Macroeconomic implications of capital controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Microeconomic implications of capital controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

How To Approach Financial Integration? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

Endnotes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

FINANCIAL GLOBALIZATION AND ECONOMIC

POLICIES

M. Ayhan Kose

Eswar S. Prasad

Kenneth Rogoff

Shang-Jin Wei

ABSTRACT

W

e review the large literature on various economic policies that could help developing

economies effectively manage the process of ?nancial globalization. Our central ?ndings indicate that

policies promoting ?nancial sector development, institutional quality and trade openness appear to help

developing countries derive the bene?ts of globalization. Similarly, sound macroeconomic policies are

an important prerequisite for ensuring that ?nancial

integration is bene?cial. However, our analysis also

tegration and economic policies is a complex one and

that there are unavoidable tensions inherent in evaluating the risks and bene?ts associated with ?nancial

globalization. In light of these tensions, structural and

macroeconomic policies often need to be tailored to

take into account country speci?c circumstances to

improve the risk-bene?t tradeoffs of ?nancial integration. Ultimately, it is essential to see ?nancial integration not just as an isolated policy goal but as part of

a broader package of reforms and supportive macroeconomic policies.

suggests that the relationship between ?nancial in-

FINANCIAL GLOBALIZATION AND ECONOMIC POLICIES

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