Abstract

The paper discusses the pros and cons of capital account liberalisation. Rather than contrasting liberalisation and regulation of capital flows as irreconcilable antagonisms, we argue that capital account liberalisation requires institutional and regulatory safeguards. Even though the effectiveness of specific capital controls cannot be taken for granted, we reject the view that financial globalisation has deprived national policymakers of the means to protect their economies against crisis. In addition to national safeguards, we assess the chances for crisis prevention and resolution on the regional level and present options to overcome institutional deficits on the global level. We conclude that reforms of the international financial architecture can help prevent illiquidity and ensure a fair burden sharing in the case of insolvency, without aggravating moral hazard behaviour of the parties involved.

Economic policy conflicts

The trade-off between financial liberalisation and financial sector stability is well known from the debate on domestic financial reforms. Theoretical considerations and empirical findings suggest that liberalised national financial systems promote economic growth in the longer run. However, financial liberalisation goes hand in hand with a higher exposure to financial crises.

Various financial crises in emerging markets during the last decade point to a similar trade-off when it comes to capital account liberalisation. Domestic financial liberalisation and the removal of capital controls have in common that local financial institutions gain more room for risky transactions.