Managing Capital Flows and Exchange Rates
KDI/EWC series on Economic Policy
Edited by Dongsoo Kang and Andrew Mason
Chapter 2: Macroprudential policies: indicators and tools
The textbook case for greater financial integration and the benefits of capital flows is well known. Financial integration allows flows of capital from capital-rich economies to capital-poor economies. These flows complement the limited domestic saving, thereby enabling increased investment, and hence growth. Proponents of the ideal of liberalized, open financial markets might nevertheless make some allowance for a slower pace of financial integration for developing or emerging economies, citing their weaker institutions and the limited capacity to absorb and benefit fully from the inflows of capital. Nevertheless, the desirability of unhindered capital mobility as a basic principle would not normally be questioned. Events during the financial crisis of 2008–09 have raised questions about the basis for the proposition that unhindered financial flows enhance economic welfare. The questions apply not only to emerging and developing economies, but also to advanced ones. The banking sector crisis in Europe has shaken confidence that advanced economies can serve as an example to emerging economies of the ultimate benefit of greater financial integration and greater financial deepening. Traditional yardsticks of financial development (e.g., the ratio of commercial bank assets to GDP) or of financial integration (e.g., cross-border claims and liabilities as a proportion of GDP) turned out instead to be amplification forces of financial distress.
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