Capital account liberalization in China: a cautionary tale

This repository item contains a policy brief from the Boston University Global Economic Governance Initiative. The Global Economic Governance Initiative (GEGI) is a research program of the Center for Finance, Law & Policy, the Frederick S. Pardee Center for the Study of the Longer-Range Future, and the Frederick S. Pardee School of Global Studies. It was founded in 2008 to advance policy-relevant knowledge about governance for financial stability, human development, and the environment.This policy brief synthesizes some of the main themes and policy recommendations discussed at a February 2014 workshop of the Pardee Task Force for Regulating Capital Flows at Boston University, and presented in this report, though the specific recommendations discussed in this brief are our own. The main message is that China would do well to draw lessons from both the economics literature and country experiences with capital account liberalization. Such an approach would guide China to adopt a carefully sequenced and cautionary approach to capital account liberalization

A Review of Japan's Bank Crisis from the Governance Perspective

Why has Japan suffered from the NPL problem for such a long time? We will answer to this question from a governance perspective that emphasizes important influence of the governance structure on bank management. In our opinion, Japan failed to motivate banks to play the role of monitoring essential to the bank-centered financial system. We will stress that there existed a vacuum of governance in the bank management in the sense that bank managers were not effectively disciplined as to attain sufficient prudence in there management. The vacuum of governance accounts for the fragility of the banking sector and, more importantly, the prolongation of the NPL problem in Japan.

Opening the Capital Account of Transition Economies: How Much and How Fast

In the late eighties, many developing countries followed the example of the most advanced countries and opened their capital account (K.A.) in an attempt to reap new gains from increased integration with the world economy. By 2000, after the wave of financial and currency crises that hurt the global economy in the last decade, enthusiasm about K.A. liberalization has much faded. Firstly, the relationship between development and capital account liberalization did not come out to be as solid as initially expected; secondly, greater capital mobility has brought about increased global financial instability. New thinking in international economics calls for proper sequencing in opening the K.A.: liberalization should proceed in step with progress in macroeconomic stability, structural reform and creation of a sound internal financial system. In this paper, we analyze to what extent and at what pace should transition economies carry out the K.A. liberalization process.http://deepblue.lib.umich.edu/bitstream/2027.42/39896/3/wp511.pd

"Financial Stability, Regulatory Buffers, and Economic Growth: Some Postrecession Regulatory Implications"

Over the past 40 years, regulatory reforms have been undertaken on the assumption that markets are efficient and self-corrective, crises are random events that are unpreventable, the purpose of an economic system is to grow, and economic growth necessarily improves well-being. This narrow framework of discussion has important implications for what is expected from financial regulation, and for its implementation. Indeed, the goal becomes developing a regulatory structure that minimizes the impact on economic growth while also providing high-enough buffers against shocks. In addition, given the overarching importance of economic growth, economic variables like profits, net worth, and low default rates have been core indicators of the financial health of banking institutions. This paper argues that the framework within which financial reforms have been discussed is not appropriate to promoting financial stability. Improving capital and liquidity buffers will not advance economic stability, and measures of profitability and delinquency are of limited use to detect problems early. The paper lays out an alternative regulatory framework and proposes a fundamental shift in the way financial regulation is performed, similar to what occurred after the Great Depression. It is argued that crises are not random, and that their magnitude can be greatly limited by specific pro-active policies. These policies would focus on understanding what Ponzi finance is, making a difference between collateral-based and income-based Ponzi finance, detecting Ponzi finance, managing financial innovations, decreasing competitions in the banking industry, ending too-big-to-fail, and deemphasizing economic growth as the overarching goal of an economic system. This fundamental change in regulatory and supervisory practices would lead to very different ways in which to check the health of our financial institutions while promoting a more sustainable economic system from both a financial and a socio-ecological point of view.Financial Crisis; Financial Regulation; Banking Supervision; Sustainability

Financial Transaction Tax: Small is Beautiful

The case for taxing financial transactions merely to raise more revenues from the financial sector is not particularly strong. Better alternatives to tax the financial sector are likely to be available. However, a tax on financial transactions could be justified in order to limit socially undesirable transactions when more direct means of doing so are unavailable for political or practical reasons. Some financial transactions are indeed likely to do more harm than good, especially when they contribute to the systemic risk of the financial system. However, such a financial transaction tax should be very small, much smaller than the negative externalities in question, because it is a blunt instrument that also drives out socially useful transactions. There is a case for taxing over-the-counter derivative transactions at a somewhat higher rate than exchange-based derivative transactions. More targeted remedies to drive out socially undesirable transactions should be sought in parallel, which would allow, after their implementation, to reduce or even phase out financialtransaction taxes

External constraint and financial crises with balance sheet effects

This paper investigates the dynamic implications of Krugman’s (1999) model of financial crises with balance-sheet effects, which has a considerable impact on the literature as well as the teaching of international financial crisis. By explicitly taking account of wealth accumulation and external equilibrium condition, it is shown that a financial crisis in emerging market economies, instead of being interpreted as a jump from a good to a bad equilibrium with zero investment and zero foreign debt, could be explained as a jump from an unstable dynamic trajectory to a stable one. The dynamic framework illustrates well the analysis of different factors at the origin of financial vulnerability and crisis. By discriminating the financial crises according to the severity of their negative impacts on the domestic economy, the present study also adds some insights in the analysis of policy implications.Financial crisis, currency crisis, balance sheet effect, external solvency constraint.

The effects of interbank networks on efficiency and stability in a macroeconomic agent-based model

We develop a macroeconomic agent-based model that consists of firms, banks, unions and households who interact on labour, goods, credit and interbank markets. The model endogenises pricing decisions by firms, wage setting by unions and interest rate setting by banks on both firm and interbank lending. Banks also set leverage targets and precautionary liquidity buffers on the basis of internal risk models. Our model produces endogenous fluctuations driven by the pricing behaviour of firms and the wage setting behaviour of unions. Fluctuations lead to loan defaults which are exacerbated as lenders reduce lending and charge higher interest rates, inducing a credit crunch. We also study how making the inter-banking network more connected affects the key outcomes of the economy and find that while the flow of funds from surplus banks to firms can be increased, the latter effect is soon dominated by increasing instability in the real sector as firms default at higher rates. While the banking sector experiences fewer defaults as a whole, losses on the interbank market increase as a source of bank defaults

Financial Globalization and Economic Development: Toward an Institutional Foundation

On the promise of enormous benefits from financial openness, many developing countries have embraced financial globalization by adopting internal and external financial liberalization. Yet, despite the rhetoric of its proponents, there is little evidence of enhanced development finance or any concomitant improvement in economic development. We critically examine the mainstream theoretical rationale for financial globalization and liberalization as well as their explanations of the widespread financial instability and crises that have been associated with financial openness. The paper also draws on broader theoretical traditions to explain the ubiquity of recent financial crises. Pointing to an alternative more dynamic analysis of the symbiotic relationships between finance and economic development, we propose an institutional-centric approach that forms a basis for understanding the transformation required for financial development. For development to occur, financial flows need to feed into real sector circuits to enhance expansion and accumulation, whilst national flows need to tap into international flows to complement the speed and capacity of the domestic flows.Developing Countries; Development; Finance; Financial Liberalization