Should capital flows be regulated? - a look at the issues and policies

The author argues that externalities in financial markets, implicit and explicit guarantees on financial transactions, and information asymmetries in financial markets that may exacerbate contagion provide a rationale for a government role in managing the risk associated with cross-border capital flows. Governments can complement private sector risk management with measures that help deal with the volatility of capital flows. These measures include those that control the type and volume of capital flows and those that help investors make better investment decisions, and that may reduce herding behavior, such as better information provision. The main instruments that have been tried or recommended since the onset of the recent financial crises can be grouped in several categories. 1) Debt management: The composition, maturity structure, and level of external debt have played an important role in financial crises. High short-term debt relative to liquid assets has been found to be consistently correlated with financial crises in recent times. Governments can affect the level of debt (including private debt) and its composition, though the mix of policies they use will vary. Prudential regulation in the financial sector, corporate sector regulation, and restrictions on capital movements have all been used with varying success to change the level and composition of external debt. 2) Other macroeconomic policies: Most countries that have suffered macroeconomic crises have had fixed exchange rate systems; some have not. But whether or not a country has a fixed exchange rate is not the relevant question. The question is instead whether there is reason to expect a significant weakening of the currency, possibly as a result of a change in policy stance. Large real exchange rate appreciations have been among the main reasons for runs on currency; macroeconomic policy needs to be aimed at managing these. With a fixed exchange rate regime, flexibility must be maintained elsewhere in the economy. Policymakers may need to make tradeoffs between price and output stability once market jitters have set in. There is no single right answer to the question of which to emphasize more at a given time; it depends on a country's circumstances. 3) Risk management in the financial sector: The health of the financial sector is related to the government's fiscal position, its macroeconomic policies, and financial crises. The regulatory and supervisory frameworks in developing countries need to be adapted to the special features of these markets. Many developing countries are subject to frequent trade and capital account shocks, while lacking the means to deal with these shocks, such as adequate insurance markets. This situation may call for policies that nor only affect the incentives of lenders, but also help manage risk more directly. Examples of such policies include maturity, and liquidity requirements. 4) Information and transparency: More disclosure of information and improvements in the quality of that information could reduce the volatility that arises from herding behavior. Ex ante, they may also have a beneficial effect on the allocation of capital.Economic Theory&Research,Payment Systems&Infrastructure,Banks&Banking Reform,Fiscal&Monetary Policy,Environmental Economics&Policies,Banks&Banking Reform,Economic Theory&Research,Environmental Economics&Policies,Macroeconomic Management,Financial Intermediation

Economic information and finance : more information means more credit, fewer bad loans, and less corruption

This paper builds on recent work that shows how financial sector outcomes are affected by the provision of information by financial and other entities. In particular, it shows that an indicator of economic transparency is positively related to higher levels of private credit and a lower share of nonperforming loans even after accounting for factors commonly believed to influence financial sector development in cross-country empirical estimation. Timely access to economic data allows investors to make better decisions on investments and to better monitor banks'financial health. Greater economic transparency raises accountability and lowers corruption in bank lending.Banks&Banking Reform,Financial Intermediation,Economic Theory&Research,Insurance&Risk Mitigation,Investment and Investment Climate

Institutional reform and the judiciary : which way forward?

The author presents some general lessons in institution-building that has relevance for judiciary reform. She emphasizes the value of simplicity in design commensurate with country capacity, the importance of innovation and experimentation, and of economic openness in effective institution-building. The author underscores how the incentives of individuals depend on both the details of institutional design within the judiciary and also some critical institutions external to the judiciary. Finally she argues for the need to ground reform initiatives on a solid empirical and comparative approach. The author illustrates some of these issues by drawing on a recent project conducted by the World Bank and other institutions.Judicial System Reform,Judicial System Reform,Legal Institutions of the Market Economy,Decentralization,Legal Products,Judicial System Reform,Legal Institutions of the Market Economy,Judicial System Reform,Children and Youth,Environmental Economics&Policies

do more transparent government govern better?

The author explores the link between information flows and governance or institutional quality. Economic theory expounds on the importance of information on economic outcomes either through its direct effect on prices and quantities or through its effect on other factors such as institutions and the quality of governance. She shows that countries with better information flows also govern better. Two kinds of indicators are used to assess better information flows. One index is based on the existence of freedom of information laws. A second index called the"transparency"index measures the frequency with which economic data are published in countries around the world. Empirical analysis shows that countries which have better information flows as measured by both indicators have better quality governance.Environmental Economics&Policies,ICT Policy and Strategies,Public Health Promotion,Decentralization,Educational Technology and Distance Education,ICT Policy and Strategies,Environmental Economics&Policies,Health Monitoring&Evaluation,Educational Technology and Distance Education,Health Economics&Finance

Does aid help improve economic institutions ?

Aid is expected to promote better living standards by raising investment and growth. But aid may also affect institutions directly. In theory, these effects may or may not work in the same direction as those on investment. The authors examine the effect of aid on economic institutions and find that aid has neither a positive nor a negative impact on existing measures of economic institutions. They find the results using pooled data for non-overlapping five-year periods, confirmed by pooled annual regressions for a large panel of countries and by pure cross-section regressions. The authors explicitly allow for time invariant effects that are country specific and find the results to be robust to model specifications, estimation methods, and different data sets.Development Economics&Aid Effectiveness,Public Institution Analysis&Assessment,Economic Theory&Research,Economic Policy, Institutions and Governance,School Health

Of floods and droughts : the economic and financial crisis of 2008

This paper provides an overview of the period prior to the recent global crisis, and the policies that were adopted around the world in response to the crisis. It highlights a number of key issues regarding economic and financial policies that governments have faced both globally and nationally. These are related to the management of boom and bust episodes that deserve more attention in policy circles in the future.Debt Markets,Emerging Markets,Currencies and Exchange Rates,Economic Theory&Research,Access to Finance

Trade and harmonization : if your institutions are good, does it matter if they are different ?

Good institutional quality (function) and similar institutional design (form) can promote international trade by reducing transactions costs. The authors evaluate the relative importance of function versus form in a gravity model, using an indicator of different legal systems as a proxy for differences in form, together with indicators of overall institutional quality. They find that good institutions promote trade much more than similar legal systems and have much more explanatory power. This effect is economically large-up to 10 times the effect of different legal systems. Moreover, better infrastructure matters as much as good institutions.Legal Products,Trade Law,Economic Theory&Research,Transport and Trade Logistics,Common Carriers Industry

What are the right institutions in a globalizing world? and... can we keep them if we have found them?

Greater trade integration has often been viewed as requiring greater standardization in institutions, without which the benefits of trade do not materialize. There are many current debates concerning the degree and area of standardization needed and these debates are likely to continue for the foreseeable future. This paper, drawing on both the fiscal federalism and the trade literature, argues that increasing trade integration is consistent with a wide array of institutional choices. The final outcome, in terms of which institutions have prevailed, has depended substantially on political pressures for standardization and not necessarily on a clear assessment of economic gains.Labor Policies,Environmental Economics&Policies,Economic Theory&Research,Decentralization,Banks&Banking Reform,Environmental Economics&Policies,Economic Theory&Research,Banks&Banking Reform,National Governance,Trade and Regional Integration

What determines the quality of institutions?

In trying to explain institutional quality, different authors have come to conflicting conclusions. In tackling the problem themselves, the authors show three things. First, openness is positively and pretty robustly associated with institutional quality. To minimize selection bias, the authors use data sets with the greatest cross-country coverage, though they also test the significance of the variables for smaller sample sizes. The results confirm that both natural and policy measures of openness are important. Concentration of trade in natural resource exports continues to be associated with poor institutional quality after openness in trade is accounted for. Second,"social"variables, such as income inequality or ethnic diversity, are not associated with institutional quality. The significance of the inequality variable disappears when continent dummy variables are included for Africa and Latin America. Third, features of specific institutions, such as freedom of the press and checks and balances in the political system, are positively associated with overall perceptions of institutional quality. These findings hold strongly across different data sets and samples even after the authors control for the variables commonly used in the literature.Decentralization,Environmental Economics&Policies,Public Institution Analysis&Assessment,Economic Theory&Research,Poverty Monitoring&Analysis,Governance Indicators,Economic Policy, Institutions and Governance,Public Institution Analysis&Assessment,Economic Theory&Research,Poverty Monitoring&Analysis

Fiscal adjustment and contingent government liabilities : case studies of the Czech Republic and Macedonia

To control the expansion of government contingent liabilities and reduce fiscal vulnerability, one must be able to identify and measure them. The authors discuss how this may be done and demonstrate how the assessment of fiscal adjustment may change substantially when a broader picture of government liabilities is included. They base their analysis on experience in analyzing fiscal adjustment in the Czech Republic and Macedonia. Their work demonstrates the importance of including contingent liabilities when analyzing fiscal sustainability. To the extent that explicit expenditures are shifted off-budget or replaced by guarantees, the achieved improvement in fiscal balances is overstated. For the Czech Republic, adjustment may have been overstated by some 3 to 4 percent of annual GDP. A stabilization program accompanied by a build-up of contingent liabilities, particularly state guarantees and obligations to cover liabilities emerging from directed credit, may not be sustainable. In Macedonia, the present fiscal equilibrium may be temporary because the stock of existing contingent liabilities could add 2 to 4 percent of GDP to future deficits. And methods used to reduce the"traditional"deficit are unlikely to be sustainable without further modification. The authors conclude that governments: 1) must find better ways to identify and evaluate contingent liabilities arising from the banking system, nonbanking financial institutions, public enterprises, or the contingent and direct liabilities of subnational governments; 2) need to better manage their risks--for example, building adequate reserve funds and hedging risk, where possible; and 3) should examine the implications of the bias toward adding contingent liabilities and develop administrative reform as part of analyzing budget management.Banks&Banking Reform,Payment Systems&Infrastructure,International Terrorism&Counterterrorism,Insurance&Risk Mitigation,Environmental Economics&Policies,Banks&Banking Reform,Insurance&Risk Mitigation,National Governance,Environmental Economics&Policies,Financial Crisis Management&Restructuring