Most people agree that the soundness of macroeconomic policies should be judged by their efficacy in meeting the objectives of steady growth, full employment, stable prices, and a viable external payments situation. What people debate about are the links between macroeconomics and economic structure--and in the current environment, the openness to foreign capital flows. As developing countries become more integrated into international financial markets, volatility may become an increasing fact of life. Faced with such volatility, how should these countries frame their macroeconomic policies? What broad principles should guide their macroeconomic management? In many developing countries, the openness of the capital account has been significant. Many countries have made the transition toward an open-economic paradigm. As a result, fluctuations in international capital and currency markets, as well as shifts in foreign investors'attitudes and confidence, have greatly affected local stock market prices, the level of foreign exchange reserves, and the scope for monetary and interest rate policy. Capital controls and foreign exchange restrictions have been significantly dismantled in a number of developing and transition economies. In 1970, only 34 countries--or 30 percent of the International Monetary Fund's membership-had assumed Article VIII of the IMF Articles of Agreement, declaring their currency convertible on current account transactions. By 1997, this figure had increased to 77 percent. Does financial integration make it more difficult to achieve macroeconomic stability? Apparently not, on the whole, although at times large short-term capital flows can lead to misaligned asset prices, including exchange rates. What financial integration does do is limit how far countries can pursue policies incompatible with medium-term financial stability. The disciplining effect of global financial and product markets applies not only to policymakers-through pressures on financial markets-but also to the private sector. Rather than constrain the pursuit of appropriate policies, globalization may add leverage and flexibility to such policies, easing financing constraints and extending the time during which countries can make adjustments. But markets will provide this leeway only if they perceive that countries are undertaking adjustments that address fundamental choices.
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