Financial integration

Abstract: The world is still a closed economy, but its regions and countries are becoming increasingly open. The trend, which has been manifested in both freer movement of goods and increased mobility of capital, has been stimulated by the dismantling of trade and exchange controls in Europe, the gradual erosion of the real burden of tariff protection, and the stability, unparalleled since 1914, of the exchange rates. The international economic climate has changed in the direction of financial integration and this has important implications for economic policy. My paper concerns the theoretical and practical implications of the increased mobility of capital. In order to present my conclusions in the simplest possible way, and to bring the implications for policy into sharpest relief, I assume the extreme degree of mobility that prevails when a country cannot maintain an interest rate different from the general level prevailing abroad. This assumption will overstate the case but it has the merit of posing a stereotype towards which international financial relations seem to be heading. At the same time it might be argued that the assumption is not far from the truth in those financial centres, of which Zurich, Amsterdam, and Brussels may be taken as examples, where the authorities already recognize their lessening ability to dominate money market conditions and insulate them from foreign influences. It should also have a high degree of relevance to a country like Canada whose financial markets are dominated to a great degree by the vast New York market.

Abstract: The recent wave of financial globalization since the mid-1980s has been marked by a surge in capital flows among industrial countries and, more notably, between industrial and developing countries. While these capital flows have been associated with high growth rates in some developing countries, a number of countries have experienced periodic collapse in growth rates and significant financial crises over the same period, crises that have exacted a serious toll in terms of macroeconomic and social costs. As a result, an intense debate has emerged in both academic and policy circles on the effects of financial integration for developing economies. But much of the debate has been based on only casual and limited empirical evidence.

Abstract: This paper develops a dynamic continuous-time model in which international risk sharing can yield substantial welfare gains through its positive effect on expected consumption growth. The mechanism linking global diversification to growth is an attendant world portfolio shift from safe, but low-yield, capital into riskier, high-yield capital. The presence of these two types of capital is meant to capture the idea that growth depends on the availability of an ever-increasing array of specialized, hence inherently risky, production inputs. A partial calibration exercise based on Penn World Table consumption data implies steady-state welfare gains from global financial integration that for some regions amount to several times initial wealth.