Financial Integration in Emerging Europe: An Enviable Development Opportunity with Tail Risks

33 Pages Posted: 8 May 2012

Date Written: May 1, 2012

Abstract

This paper draws on the experience of emerging Europe and argues that foreign capital is an enviable development opportunity with tail risks. Financial integration and foreign savings supported growth in the EU12 and EU candidate countries. We argue that this was possible because of EU membership (actual or potential) and its role as an anchor for expectations. In contrast, the eastern partnership states did not benefit from the foreign savings-growth link. But financial integration also led to a buildup of vulnerabilities and now exposes emerging Europe to prolonged uncertainty and financial deleveraging due to eurozone developments. Nonetheless, we believe that external imbalances should not be eradicated - nor should emerging Europe pursue a policy of self-insurance. Instead, what we refer to as an acyclical fiscal policy stance could serve to counterbalance private sector behavior. Going forward, a more proactive macroprudential policy will also be needed to limit financial system vulnerabilities when external imbalances are large.

Keywords: financial integration, emerging Europe, capital inflows, growth, macroprudential

JEL Classification: E58, F36, F41, G28

Suggested Citation

Iwulska, Aleksandra and Sugawara, Naotaka and Zalduendo, Juan, Financial Integration in Emerging Europe: An Enviable Development Opportunity with Tail Risks (May 1, 2012). CASE Network Studies and Analyses No. 438/2012. Available at SSRN: https://ssrn.com/abstract=2054555 or http://dx.doi.org/10.2139/ssrn.2054555

Aleksandra Iwulska (Contact Author)

affiliation not provided to SSRN ( email )

Naotaka Sugawara

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Juan Zalduendo

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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