Department of Economics, UCSC

The accumulated experience of emerging markets over the last two decades has laid bare thetenuous links between external financial integration and faster growth on the one hand and theproclivity of such integration to fuel costly crises on the other. These crises have not gonewithout learning. During the 1990s and 2000s, emerging markets converged to the middleground of the policy space defined by the macroeconomic trilemma, with growing financialintegration, controlled exchange rate flexibility and proactive monetary policy. The OECDcountries moved much faster towards financial integration, embracing financial liberalization,opting for a common currency in Europe, and for flexible exchange rates in other OECDcountries. Following their crises of 1997-2001, emerging markets added financial stability as agoal, self-insured by building up international reserves and adopted a public finance approach tofinancial integration. The global crisis of 2008-09, which originated in the financial sector ofadvanced economies, meant that the OECD “overshot” the optimal degree of financialderegulation while the remarkable resilience of the emerging markets validated their publicfinance approach to financial integration. The story is not over: with capital flowing in droves toemerging markets once again, history could repeat itself without dynamic measures to managecapital mobility as part of a comprehensive prudential regulation effort.