International Financial Integration. Is it worth it

We be witnessing the transformation of meld-20th one C managerial comportantism Into global fiscal majusculeism. This Is what Martin Wolf expressed In an article pen for the Financial Times In June 18, 2007. Even after the global economic crawls that followed the next years and from which the piece Is still recovering, this statement Is of great relevance.Actually, this crawls Is a good example of how Integrated the worlds monetary markets re chip father a financial crisis that started In some developed countries practically spread throughout the whole world. As Wolf himself hinted in his book Fixing Global Finance, it is obvious wherefore financial crises bounce okay from one country to another (2008, p. 25).First, markets are connected globally, both for commodities and financial instruments second, an unexpected weakness in one country is seen by investors as a weakness for apparently similar countries third, when political relations fail to answer to financial crise s as expected, trust in their departingness to act elsewhere entrust be lost fourth, a high perception of jeopardize in one market may spread to others and fifth, the rationing of reedit to risk borrowers chiffonier turn a slight instableness into a crisis (Wolf, 2008, p. 5). Likewise, Jeffrey Freddie adds that current regulations and technology allow gravid to travel around borders almost instantly, giving rise to hapless-term inter case transactions (Freddie, 1991, p. 428). With such vulnerabilities, to what finale is inter content financial integration (capital mobility) worth it? To answer this question, this paper will try to explain how and why capital mobility alters economic politymaking by political sympathiess as well as the tradeoffs such policies entail.By doing so, it will show the head to which capital mobility takes policy autonomy away from governments and Indicates how It can affect certain countries more than others. To do so, number 1 the concept of the open economy jack-in-the-pulpit will be illustrated. Followed policymaking and its interaction with substitution-rate stability and macro-economic independence and the becharm this has in incompatible countries.The Unholy Trinity Also known as the open economy trillium or the Mendel-Fleming Model in reminiscence to the economists that graduation set forth the concept, it indicates that overspent must choose amongst deuce of three goals capital mobility (CM), exchange-rate stability, or monetary independence (Freddie, 2008, p. 347). Giving up CM implies placing capital controls that ultimately close world markets to a country. This is what the Latin American nations practiced from the sasss until the sasss with their import-substitution industrialization (IS) policy (Freddie, 2007, p. 10-312). On the contrary, in a financially integrated world as today, the trade-off is between exchanger stability and domestic help monetary policy autonomy. If the latter is referred, th e exchanger will hasten to be allowed to fluctuate. For example, if a government deficiencys to encourage investment and append employment, policymakers will pursue low interest rate. Hence, many investors will want to move their investments to another country that offers higher interest rates.When the capital leaves the country, demand for the local currency will 2 decrease and it will end up depreciating at that place is no exchange-rate stability (Walter, 2013, p. 22). Conversely, if policymakers cull exchange-rate stability, they need to subject monetary policy solely to this goal. To neutralize depreciation or appreciation, interest rates still have to be lowered or increased, but they cannot be used for domestic objectives such as encouraging investment or promoting a rise in consumption (Walter, 2013, p. 22).With this model in mind, I now pass to explain how and why CM alters autonomous economic policymaking by governments, first by indicating its influence and then by explaining its interaction with the other two goals of the economy trillium. Influence of CM in national economic policymaking worth asking what are the benefits of CM that make it incontestable in todays world? Benefits of CM For one part, CM allows countries to borrow from the rest of the world in order to reform their ability to produce goods and services (Newly, 1999, p. 1 5).In doing so, goods and services from other parts of the world compete in local markets. This creates a more competitive environment, driving down profits and forcing companies to seek finance from impertinent (Wolf, 2008, p. 22). Due to the increased competitiveness, a global financial system can benefit the quality of domestic regulation there will be pressure for better accounting 3 standards and an improved legitimate and financial system (Wolf, 2008, p. 3). In this sense, it will encourage companies to lobby for a more efficient, flexible and handy financial system (Wolf, 2008, p. 3). Linked to comp etition, such financial systems can encourage governments to re- think their policies (avoid requesting too much taxes or allowing too much inflation, for example) and pr pointt capital outflows (Wolf, 2008, p. 23). Also, CM allows risk diversification and technology transfer (Wolf, 2008, p. 23). Furthermore, in many developing countries the economy is not big enough for its citizens nest egg to finance world-level institutions. This is an important tilt for allowing the presence of foreign banks (Wolf, 2008, p. 23).For example, between 1960 and 1980 South Korea annually requested funds from international sources equivalent to 4. 3% of its GAP to finance its strong economic growth (Newly, 1999, p. In addition, capital flows allow countries to avoid boastful drawbacks in consumption from economic crises by selling assets to and/or borrowing from outside sources (Newly, 1999, p. 1 5). It was on the button through foreign lending that Mexico and Argentina were able to overcome thei r 1995 crisis (Grumman, 2008 p. 51). All in all, capital flows can be beneficial for a nation.However, this type of global integration is likely to generate crisis if pursued with a low level of economic development (Wolf, 2008, p. 24). Citizens in developed countries may have enough savings inside the national financial system to allow their governments to leverage enough investment and growth. However, developing countries will most likely depend on capital inflows for this and even more urgently when an economic imbalance occurs. Hence, many countries in the past have used capital controls to limit the harmful effects (Grumman, 2008, p. 107).Pinpointing on this last issue, what exceeds a country to prefer a fixed exchange-rate and monetary autonomy over CM? In short, the control of capital flows helps a country have economic stability (Newly, 1999, p. 21). As investors have limited information about the true value of the assets they hold in the country, they tend to infer from the actions of others, creating a herding behavior, where asset set variations cause further changes in the same direction, leading to a boom-bust cycle and macro-economic instability, indeed Justifying capital controls (Wolf, 2008, p. 25).There are different ways this is sought by todays governments. Control of CM First, capital controls may be used to discourage capital outflows in the event of a crisis, allowing the central bank (CB) to have invulnerability with domestic monetary policy. This is how Malaysia responded to its 1998 crisis (Newly, 1999, p. 19). -. Second, economic stability can be achieved by preventing destabilize outflows in the first place, in other words, changing the composition of capital inflows (Newly, 1999, p. 21). Through capital inflow controls, the government helps prevent future and sudden outflows by investors.This is what cayenne pepper practiced in the sasss. By scrounging capital inflows, Chile was able to limit the number of volatile capital tha t could have left the country on short notice (Newly, 1999, p. 21). 5 Likewise, at present the International Monetary Fund (MIFF) is recommending capital flow caution measures after exhausting interest-rate adjustment and if implemented alongside foreign exchange-rate reserves accumulation and macro- prudential financial regulation (Gallagher, 2012). As mentioned above, the aim of CM controls is macro-economic stability.I will now further explain the origins why CM causes economic instability in the first place. There are two reasons either they are the result of irresponsible behavior in the markets or of bad policies by local authorities (Change, 1999, p. 7). The former reason has to do with human attitudes while in economic boom, there is excess of greed in recession, there is excess of fear (Wolf, 2008, p. 21). This leads, as explained above, to the panic and herding effect. Market that make it inherently risky adverse selection, object lesson hazards, and asymmetric informa tion (Wolf, 2008, 19).The unfortunate intervention of a government (wrong or bad fiscal and/or monetary policies) often makes them even sees safe, as is the case of poor fiscal discipline added to a wishing of monetary discipline (Wolf, 2008, 22). Likewise, mistakes in exchange-rate policy can greatly affect the financial market as will be described in the next section. Both of these reasons affect the other two goals of the pixilated trinity exchange-rate stability and monetary independence. We will be able to see this by explaining the interactions of CM with these two other goals.Interaction of CM with exchange-rate stability and macro-economic independence 6 To provide a sense of how CM interacts with exchange-rate and macro-economic lollygagging, different scenarios are analyzed fixed vs. fluctuated exchange-rate and the efficacy of monetary and fiscal policies. First, the efficacy of fiscal policy in a country with a fixed exchange-rate and CM will be considered. Supposing t hat a government seeks to amaze national income, it will pursue an increase in commingle demand by increasing government spending and/or reducing taxes.Consequently, interest rates will go up and an inflow of capital from abroad will arrive. This capital inflow would lead to an excess supply of foreign currency. Therefore, as the exchange rate is sweep throughged, the country CB would have to ay that excess supply with national currency, thus stimulating the national income even more. Although this might seem ideal, the ultimate consequence is a detriment of the country international competitiveness exports would fit more expensive to the world and imports cheaper for the locals (Greece, 2003, p. 87).Accordingly, international investors would lose confidence in the governments capacity to sustain a current account deficit brought by the capital inflow, as well as probable price inflation due to the fiscal expansion , and move their money somewhere else (Greece, 2003, p. 7). Now with a capital outflow, the CB would seek to raise interest rates, which leads to a decrease in investment and consumption, thus reducing aggregate demand and counteracting the national income stimuli (Greece, 2003, p. 87). From a monetary policy perspective, the prospect is not positive either.If the economy wants to be stimulated, the CB would have to reduce interest rates which currency would exceed its demand, and in order to maintain its peg the country CB would have to buy the excess with 7 its foreign exchange reserves. The national currency drop-off circulating in the economy and the consequent increase in interest rates and decrease of income and consumption would end up cutting the national income stimuli also (Greece, 2003, p. Now, considering a flexible exchange-rate and, again, supposing a fiscal policy intended to boost national income and hence a rise in interest rates, the country would expect capital inflows.Therefore, there is an increase in demand for the nationa l currency, which would appreciate in value, causing imports to be less expensive in the local market and exports more expensive abroad. Accordingly, the country would lose in international competitiveness and the probable reduction of sports (because they are now more expensive for the world) would decrease national income (Greece, 2003, p. 88). On the other hand, regarding monetary policy with a flexible exchange-rate, some political scientists consider that it has strengthened as the world has become more integrated (Greece, 2003, p. 89).When a governments goal is an increase in national income, the natural response is to lower interest rates. This would provoke a capital outflow from the country, which in turn brings depreciation of its currency and hence a competitive edge in the international market. This effect would increase aggregate emend and national income even more (Greece, 2003, p. 89). However, policy preferences of economic interest groups differ within a country (F reddie, 1991 , p. 432 and Walter, 2008, p. 406). Therefore, those who depend on imports, for example, will prefer a stronger local currency (Freddie, 1991, p. 45). This is, for example, Thailand regard with its 1997 economic crisis (Walter, 2008, p. 422). Thailand economy was, and still is, export-oriented. However, in 1997 the majority of its exporters produced industrial goods that needed imported inputs. Therefore, the depreciation ad no real competitive effect (Walter, 2008, p. 422). 8 Developing countries and CM As economic and financial markets in developed countries provide more stability to investors, as seen with the above interactions developing countries are more externalities on recipient countries (Gallagher, 2012).In this sense, regulating CM is an optimal tool to address market failures and enhance growth, not worsen it (Gallagher, 2012). Conclusion International financial integration alters national economic policymaking. This can be unsounded by first looking at t he Mendel-Fleming Model and the influence and interaction of CM with exchange-rate stability and macro-economic independence. In todays world, CM has priority over the two other goals. However, there are certain traits that can lead a country into an imbalance or even a deep crisis, especially for developing countries.Hence, the level of openness to CM must be studied against the economic development of the country and its financial health. Countries are the custodians of national economic stability and well-being.