Does Financial Globalization Induce Better Macroeconomic Policies?

41 Pages Posted: 15 Feb 2006

See all articles by Irina Tytell

Irina Tytell

Fidelity Investments; International Monetary Fund (IMF)

Shang-Jin Wei

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); International Monetary Fund (IMF); Tsinghua University - School of Economics & Management

Date Written: May 2004

Abstract

Monetary and fiscal policies around the world are in better shape today than two decades ago. This paper studies whether financial globalization has helped induce governments to pursue better macroeconomic policies (the "discipline effect"). The empirical tests have two innovations. First, we recognize potential endogeneity of the observed capital flows in a given country and employ an instrumental variable approach that relies on the autonomous (global) component of the capital flows. Second, we recognize inherent discreteness in defining good versus bad macroeconomic policies and use a transition matrix technique to determine whether capital flows are effective in inducing substantial qualitative policy shifts. Our results suggest that, in spite of the plausibility of the "discipline effect" in theory, it is not easy to find strong and robust causal evidence. There is some evidence that financial globalization may have induced countries to pursue low-inflation monetary policies. However, there is no evidence that it has encouraged low budget deficits.

Keywords: Discipline effect, capital flows, mood swings, inflation, deficit

JEL Classification: F3

Suggested Citation

Tytell, Irina and Wei, Shang-Jin, Does Financial Globalization Induce Better Macroeconomic Policies? (May 2004). IMF Working Paper, Vol. , pp. 1-41, 2004. Available at SSRN: https://ssrn.com/abstract=878907

Irina Tytell (Contact Author)

Fidelity Investments ( email )

245 Summer Street
Boston, MA 02210
United States

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Shang-Jin Wei

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

International Monetary Fund (IMF)

700 19th Street, N.W.
Washington, DC 20431
United States

Tsinghua University - School of Economics & Management

Beijing, 100084
China

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