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Does Financial Globalization Induce Better Macroeconomic Policies?

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  • Shang-Jin Wei
  • Irina Tytell

Abstract

Monetary and fiscal policies around the world are in better shape today than two decades ago. This paper studies whether financial globalization has helped induce governments to pursue better macroeconomic policies (the "discipline effect"). The empirical tests have two innovations. First, we recognize potential endogeneity of the observed capital flows in a given country and employ an instrumental variable approach that relies on the autonomous (global) component of the capital flows. Second, we recognize inherent discreteness in defining good versus bad macroeconomic policies and use a transition matrix technique to determine whether capital flows are effective in inducing substantial qualitative policy shifts. Our results suggest that, in spite of the plausibility of the "discipline effect" in theory, it is not easy to find strong and robust causal evidence. There is some evidence that financial globalization may have induced countries to pursue low-inflation monetary policies. However, there is no evidence that it has encouraged low budget deficits.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/84.

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Length: 40
Date of creation: 01 May 2004
Date of revision:
Handle: RePEc:imf:imfwpa:04/84

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Keywords: Capital flows; Financial sector; Inflation targeting; inflation; globalization; financial globalization; foreign assets; inflation rates; high inflation; low inflation; international financial; inflation rate; monetary policy; financial integration; inflation equation; international financial integration; international financial statistics; annual inflation; international finance; lower inflation; exchange rates; high inflations; macroeconomic stability; annual inflation rate; international investment; inflation observations; price stability; moderate inflation; capital markets; dollar value; inflation across countries; economic integration; inflation crises; actual inflation; global integration; globalization of securities markets; percent inflation; global capital; reduction in inflation; foreign liabilities; globalization of securities;

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References

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  1. Hali J. Edison & Michael W. Klein & Luca Antonio Ricci & Torsten Sløk, 2004. "Capital Account Liberalization and Economic Performance: Survey and Synthesis," IMF Staff Papers, Palgrave Macmillan, vol. 51(2), pages 2.
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  13. Michael Bruno & William Easterly, 1995. "Inflation Crises and Long-Run Growth," NBER Working Papers 5209, National Bureau of Economic Research, Inc.
  14. Torsten Sløk & Michael Klein & Luca Antonio Ricci & Hali J. Edison, 2002. "Capital Account Liberalization and Economic Performance," IMF Working Papers 02/120, International Monetary Fund.
  15. Atish R. Ghosh & Anne-Marie Gulde & Holger C. Wolf, 2003. "Exchange Rate Regimes: Choices and Consequences," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262072408, December.
  16. Stiglitz, Joseph E., 2000. "Capital Market Liberalization, Economic Growth, and Instability," World Development, Elsevier, Elsevier, vol. 28(6), pages 1075-1086, June.
  17. Woochan Kim, 2003. "Does Capital Account Liberalization Discipline Budget Deficit?," Review of International Economics, Wiley Blackwell, Wiley Blackwell, vol. 11(5), pages 830-844, November.
  18. M. Ayhan Kose & Kenneth Rogoff & Eswar Prasad & Shang-Jin Wei, 2003. "Effects of Financial Globalization on Developing Countries," IMF Occasional Papers 220, International Monetary Fund.
  19. Rogoff, Kenneth, 1985. "Can international monetary policy cooperation be counterproductive?," Journal of International Economics, Elsevier, Elsevier, vol. 18(3-4), pages 199-217, May.
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