What's Wrong with International Financial Markets?

Abstract

Recent financial crises and contagion puts into question the wisdom of capital account liberalization. There is consensus that something is terribly wrong in the way international financial markets work for developing countries and that fixing is urgent. But what is wrong? Most views in developed countries identify the problems with too much capital flows, attracted by moral hazard. However, our analysis shows that the role of this distortion is being grossly exaggerated and that, in contrast, the main distortions in international financial markets are associated with capital flows being too little, restricted by sovereign risk, and too volatile because of market failures.

Keywords: international financial architecture, financial rescue, bailout, financial crisis, liquidity crisis, financial contagion

JEL Classification: F33, F34, G15