Benoît Coeuré: Paradigm lost - rethinking international adjustments
Text of the Egon and Joan von Kashnitz Lecture by Mr Benoît Coeuré, Member of the
Executive Board of the European Central Bank, at the Clausen Center for International
Business and Policy, Berkeley, 21 November 2015.
* * *
I would like to thank R. Beck and G. Georgiadis for their assistance in preparing this lecture and M. Bussière,
L. Dedola, L. Laeven, F. Moss and G. Pineau for their comments. I also thank P.-O. Gourinchas for useful
discussions. All views expressed herein remain mine.
Summary
Central banks today operate in a highly interconnected world. They need a profound
understanding of the international macroeconomics adjustment process. The research
community can help policy makers answering their fundamental questions about
globalization and shaping their response in terms of governance and regulation.
During the past two decades, policy discussion in fora such as the IMF, G7 or G20 have
been predicated on three key assumptions about that process: reallocation of aggregate
demand across economies would sustain an appropriate pace of global growth; freely
floating exchange rates would support such demand and act as shock absorbers; and cross
border capital flows make international adjustment smoother and improve the global
allocation of capital.
But recent theoretical and empirical research has started deconstructing these three
assumptions. First, the capacity of the global economy to generate growth is under question.
In a global zero lower bound environment, surplus countries hold world output down.
Second, global interconnectedness seems to have altered the shock absorbing role of
floating exchange rates. And finally, academics have questioned the resource allocation and
risk-sharing benefits of cross-border capital flows, while capital controls, or as recently
dubbed capital flow management measures, are once again part of the policy discussion.
In light of these discussions, is there a case for rethinking international macro adjustments
and the functioning of the International Monetary System? And can we shape financial
regulation in a way to reap the benefits of a global financial integration? The way academics
and policy makers address those open issues in international economics will condition the
resilience of the global economic system, i.e. its capacity to return to equilibrium without
policy intervention. This is of key importance to central bankers. If we ignore those issues,
there is a risk that monetary policies may become ineffective, overburdened, and/or
collectively trapped in a suboptimal equilibrium.
Ladies and gentlemen,
Let me first thank the organisers of this conference for inviting me to deliver the Egon and
Joan von Kaschnitz Lecture. It is an honour for me to speak to an audience of distinguished
academics who have shaped the intellectual debates in the field of international economics
and finance over the past decades.
Central banks today operate in a highly interconnected world. To fulfil our mandates we have
to both anticipate and react to swings in global commodity markets, trends in foreign demand
and spillovers from international financial markets. And in recent years, these swings and
adjustments have occurred more rapidly and with higher amplitudes, further complicating the
life for central bankers. Our reaction functions therefore become commensurately more
complex, tied not only to how domestic markets for products, labour and capital adjust to
shocks and react to policy impulses, but also crucially to adjustments in cross-border
markets. This requires a profound understanding of the international macroeconomic
adjustment process.
In particular, during the past two decades, policy discussions in fora such as the IMF, the G7
and G20 have been predicated on three key assumptions about that process. The first
assumption, in response to shocks hitting individual economies, is that a reallocation (or
"rotation" in policymaker parlance) of aggregate demand across economies would sustain an
appropriate pace of global growth. The second assumption is that freely floating exchange
rates would support such shifts in demand and generally act as shock absorbers in the global
economy. And the third is that cross-border capital flows bring the benefit of risk-sharing and
make international adjustments smoother, in addition to supporting an efficient international
allocation of capital.
The starting point of my remarks today is the recognition that recent theoretical and empirical
research has started challenging these three assumptions.
First, the capacity of the global economy to generate growth is under question. In an
environment of low global growth, export-led strategies may be relevant for one economy,
but in the aggregate they are bound to fail and they risk leading the global economy into a
high saving, low real interest rate trap. There is in other words a fallacy of composition. We
lack a clear vision of the combination of demand and supply side policies, and the broader
design of the global economy, which will support growth beyond the short-term impulse
provided by fiscal or monetary policy at the individual country level.
Second, a body of recent research has suggested that global interconnectedness may not
have enhanced the shock-absorbing role of floating exchange rates, but rather eroded it, or
at least modified it in many ways. If this is confirmed, we may have to modify the prior that
under flexible exchange rates, economies become more resilient, when each of them
becomes more open.
And finally, there is a paradox of international financial integration: as Raghu Rajan famously
suggested, for all its theoretical appeal, financial development may have "made the world
riskier".1 Academics have questioned the resource allocation and risk-sharing benefits of
cross-border capital flows; capital controls, or as recently dubbed capital flow management
measures, are once again part of the policy discussion; and financial deglobalisation, some
indicators say, may be already under way. Can we let this happen with a light heart? Or can
we shape financial regulation and other policies so as to keep reaping the benefits of global
financial integration?
The way in which we address these open issues will condition the resilience of the global
economic system, i.e. its capacity to return to equilibrium without policy intervention. This is
of key importance for central bankers. If we ignore these issues, there is a risk that monetary
policies may become ineffective, overburdened, and/or collectively trapped in suboptimal
equilibria. Although my remarks today are focused on international adjustment, the
challenges faced by the euro area - as a "microcosm" of the global economy - can provide
useful insights.
Global growth: the fallacy of composition
My first point is motivated by the ongoing discussions about economic policies that can
incentivise sustainable growth globally. This matters for central banks locally because
monetary policy cannot do all the heavy lifting of stabilising our economies in place of other
policies; and it matters globally, to avoid low global growth encouraging central banks to
adopt beggar-thy-neighbour policies.
In principle, the process of opening global markets - or globalisation - should make global
growth more resilient by allowing policymakers around the world to factor in external demand
when designing their growth strategies. If global business cycles are not fully synchronised,
external demand acts as an automatic stabiliser - economies in downswings can export their
way out while those in upswings generate the necessary domestic demand. And indeed, it is
well known that global growth in recent years has been supported by emerging markets, at a
time when several advanced economies were mired in post-crisis balance sheet recessions.
To my mind, however, this is not a sustainable global growth model as it relies, as I said, on
a fallacy of composition. While it may hold in a situation where economies face a stream of
negatively correlated idiosyncratic shocks, it clearly breaks down when all economies are hit
by the same shock or a set of positively correlated shocks. By definition not all jurisdictions
can simultaneously run a current account surplus - one cannot export to the moon. We are
in fact seeing this today, as emerging markets slow down while demand growth in advanced
economies is not sufficiently robust to pick up the slack. If every economy were to react to
their domestic challenges by exporting their slack, it would only trigger a race to the bottom.
A global growth model where each relies on the other's external demand yields an inferior
Nash equilibrium.
That equilibrium is likely to be further worsened in a situation where interest rates run up
against the zero lower bound (ZLB), as we see across advanced economies today. This not
only reduces the scope for conventional monetary policy to support domestic demand.
Recent research by Ricardo Caballero, Pierre-Olivier Gourinchas and Emmanuel Fahri
suggests that the ZLB also prevents global interest rates from falling low enough for global
asset markets to clear (i.e. global demand for financial assets exceeds their supply).2 In such
an environment, if countries would run continuous current account surpluses, the world
interest rate would fall until it hits the zero bound. The global economy would be in a
permanent liquidity trap, at which point the adjustment would take place in the form of a
world recession propagated by global imbalances. In other words, the model suggests that in
a global ZLB environment, surplus countries can hold world output down, and even countries
which in autarky would avoid falling in a liquidity trap may then be dragged down.
The role of current account surpluses in suppressing global growth - or the so-called "global
savings glut" - was identified by Ben Bernanke back in 2005.3 Since then, the euro area has
added to that global glut in a time while others have been reducing it. While the US current
account deficit has decreased by half and Japan's has disappeared, the euro area has built
up an increasing current account surplus, driven by a lasting incapacity to revive domestic
demand. What all this points to is a need to rebalance the sources of global growth.
Admittedly, there is plenty of literature on how to address the problem from the demand side.
Obstfeld and Rogoff famously argue that national policymakers who pursue domestically
optimal stabilisation policies can come close to achieving a globally optimal solution.4 This
includes, of course, a role for monetary policy, and central banks should not shy away from
that responsibility. But as already explained, in a global ZLB environment the "own house in
order" argument may not be valid any more.
In the framework of Caballero et al., the best policy responses to the "global liquidity trap",
which are not zero-sum at the global level, include safe public debt issuance and increases
in government spending. Likewise, Larry Summers recently argued that the best way to
avoid a permanent liquidity trap and the resulting secular stagnation is to promote public or
private investment.5 In economies that have sufficient fiscal space, it is indeed hard to see
how fiscal expansions at the zero lower bound would not be a positive sum for the global
economy. I would however qualify the policy advice for economies where the fiscal space is
squeezed by high and growing public debt, as is the case across most of the euro area
today.
Still, achieving sustainable economic growth is always about both demand and supply.6 And
what I think is missing from our current understanding is a coherent view of what to do on the
supply side. The composition of demand that we see in many advanced economies suggests
that supply is also a drag on stronger global growth. In the euro area in particular, private
investment is not playing the accelerating role that one would expect at this stage of the
business cycle, despite domestic demand gradually strengthening. One reason for that is the
depressed expectations of future potential growth, which lead firms to expect permanently
lower incomes and profits.7 Public investment, in particular in infrastructure and education, as
the October 2014 IMF World Economic Outlook has pointed at as an additional source of
stronger growth of current as well as potential output, is also not being accorded much of a
role, as advanced countries tend to see this as a preferred source for cutting high public
deficits.8
But weak investment demand in turn adds to the downward pressure on the equilibrium real
rates generated by a combination of low economic growth and high external surpluses, and
makes it more likely that monetary policies will repeatedly hit the ZLB. Another reason for
weakening investment is the existence of debt overhang. High levels of corporate short-term
debt in combination with increasing rollover risk can hold back real investment in the
economy.9
What all this suggests is that, if countries wait for others to move first rather than taking
action to raise future income or to address high level of debt overhang, they risk trapping
themselves in a low growth, low interest rate equilibrium - and holding the global economy
hostage.
My point here is not to disregard the complex interaction between demand and supply
factors, and the possibility that hysteresis has contributed to the post-crisis slowdown in
output growth.10 And as I said, fiscal policy should contribute where it is available. But I want
to stress that we need to enhance our understanding of the supply side so we can better
appreciate its interactions with demand. For instance, we know too little about which policies
5
See Summers, L. (2015), "Rethinking Secular Stagnation After Seventeen Months." IMF Rethinking Macro III
Conference, 16 April.
6
See Coeuré, B. (2014), "Structural reforms: learning the right lessons from the crisis", keynote speech at the
Economic conference, Latvijas Banka, Riga, 17 October.
7
For a discussion on the sources of slow productivity growth, see Gordon, R. (2015), "Secular Stagnation: A
Supply-Side View." Presentation delivered at the 2015 AEA meetings, Boston, January 3 . On the relationship
between expected earnings and investment, see Gennaioli, N., Yueran, M., and A. Shleifer (2015),
"Expectations and Investment." NBER Macroeconomics Annual 2015.
8
See Bacchiocchi, E., E. Borghi and A. Missale (2011), "Public Investment under Fiscal Constraints". Fiscal
Studies 32(1), pp. 11-42.
9
See Kalemli-Özcan, S., Laeven, L., and D. Moreno (2015), "Debt Overhang, Rollover Risk and Investment in
Europe", mimeo.
10
See Blanchard, O., Cerutti, E., and L. Summers (2015), "Inflation and Activity - Two Explorations and their
Monetary Policy Implications", IMF Working Paper No. 15/230. The authors note that hystereris can be
sizeable, but depending on the evolution of the (unobservable) underlying growth trend, the consequences are
conflicting for monetary policy: in the presence of hysteresis, output deviation from its optimal level can be
long lasting and call for a strong monetary response; but the response may prove too strong if we understand
too late that the underlying trend has in fact changed.
will extend the benefits of micro-level reforms to the macroeconomy. The empirical debate is
also still raging over the short-term impact of such reforms on output, especially at the lower
bound.11 And the optimal pace of supply side reforms has not been established empirically,
although recent euro area experience teaches us that gradualism can entrench
disinflationary expectations in a much deeper way than a one-off adjustment would have
achieved.12 Neither is the optimal sequencing of structural reforms sufficiently well
understood beyond the general concensus that such reforms should initally be more demand
than supply-enhancing, hence focused more on product than on labour markets at the
outset, in order not to add to a deflationary wage/price spiral.
So here, in my view, is a gap that research needs to fill. Forging an intellectual consensus
around these issues would inform both the G20 debate at the global level on how to create a
framework for "Strong, Sustainable and Balanced Growth", as well as national discussions
on how to raise weak potential output. "Structural reform" is a term that policymakers like to
utter, but it is often too vague to be meaningful.
In particular, my hope is that work in this area can help policymaking escape the obsession
of "competitiveness" which, when narrowly defined, focuses on export market shares, real
exchange rates and unit labour costs (Coeuré, 2014). Such an approach indeed risks
perpetuating the fallacy of composition where all economies aim to export low demand. A
positive-sum solution to global growth requires a global productivity shock, and in that regard
we need better evidence on two things. First, on what types of policies will spur domestic
total factor productivity growth through innovation, technology adoption and reallocation, and
how to optimally sequence those policies to yield the largest short-term gains. Second, we
need better evidence on the broader design of the global economy which will encourage
productivity spill-overs and the reallocation of capital and labour between economies,
restarting what researchers at the OECD have termed the stalled "diffusion machine".13
Similar reflections are needed for the euro area, where most countries have now restored an
external balance after a painful but necessary period of internal devaluation, and where
corporate investment is inhibited by expectations of depressed long-term output growth. It is
high time that the growth narrative is shifted from a narrow view of "competitiveness" towards
a broader understanding of "productivity", both within countries and across countries,
including through a stronger Single Market. Countries should no longer wait for each other to
generate sustainable growth.
Exchange rates: the role of openness
My second point is related to the importance of flexible exchange rate for the international
macroeconomic adjustment. The case for flexible exchange rates as macroeconomic shock
absorbers was made as early as 1953 by Milton Friedman. Evidence for developing
countries in the post-Bretton Woods era seemed to confirm that view, at least for emerging
market economies.14 The world's major central banks have been operating on the basis of
the Mundell-Fleming assumption that their ability to conduct independent monetary policy
relies on exchange rates being flexible - and that assumption is still hardwired into G7 and
G20 doctrine.15 This benign view of the role of exchange rates, however, has been
challenged on several accounts.
Early on, Mike Mussa noted that contrary to the notion of nominal exchange rate regime
neutrality, real exchange rates were much more volatile under flexible than under pegged
nominal exchange rate regimes. Another widely-known stylised fact questioning their role as
shock absorbers is that, while exchange rates display far greater volatility under floating
regimes, macroeconomic variables do not - another manifestation of the so-called
"exchange rate disconnect".16 But now we know that certain real-world features that were not
originally part of our structural models explain the "Mussa puzzle" and related observations.17
One such feature is trade invoicing patterns.18 Specifically, under producer-currency invoicing
exchange rate fluctuations impact on an economy's import prices, and thereby on its inflation
rate, while under local-currency invoicing exchange rate pass-through is smaller. At the same
time, for quantities, producer-currency invoicing implies a high elasticity of foreign demand to
exchange rate fluctuations, while local-currency invoicing implies that foreign demand
responds less strongly and the profit margins of exporters fluctuate more. Recent studies
indeed suggest that the impact of exchange rates on domestic prices differs substantially
across countries. For the euro area, ECB staff research recently found that an increase in the
share of the euro as an invoicing currency can lower exchange rate pass-through
considerably.19
Indeed, structural changes can have a significant impact on the role of the exchange rate as
a shock absorber. But a rise in openness, in contrast to the results of earlier international
macro-models, does not necessarily lead to an increase in exchange rate pass-through. As
countries become more vertically integrated via global value chains, exchange rate variations
will have a diminishing impact on the terms of trade. Vertical integration means that exports
are produced using imported inputs. And this means that the prices of imported
intermediates move in the same direction as the price of the economy's exports. For
example, recent research from the World Bank finds that between 1996 and 2012 the
elasticity of manufacturing export volumes to the real effective exchange rate has decreased,
15
See the G20 Finance Ministers and Central Bank Governors communiqué of 4-5 September 2015: "We
reiterate our commitment to move toward more market-determined exchange rate systems and exchange rate
flexibility to reflect underlying fundamentals, and avoid persistent exchange rate misalignments".
16
The Mussa puzzle is laid out in Mussa, M. (1986), "Nominal exchange rate regimes and the behavior of real
exchange rates: Evidence and implications", Carnegie-Rochester Conference Series on Public Policy, 25(1),
pp. 117-214. The evidence on the lack of relationship between the exchange rate regime and macroeconomic
outcomes is discussed is Baxter, M., and A. Stockman (1989), "Business cycles and the exchange-rate
regime: Some international evidence", Journal of Monetary Economics, 23(3), pages 377-400; , Flood, R.,
and A. Rose (1995), "Fixing exchange rates: A virtual quest for fundamentals", Journal of Monetary
Economics, 36(1), pp. 3-37. and Rose, A. (2011), "Exchange Rate Regimes in the Modern Era: Fixed,
Floating, and Flaky." Journal of Economic Literature, 49(3), pp. 652-72.
17
See Betts, C., and M. Devereux (2000), "Exchange rate dynamics in a model of pricing-to-market", Journal of
International Economics, 50(1), pp. 215-244. and Devereux, M., and C. Engel (2002), "Exchange rate
passthrough, exchange rate volatility, and exchange rate disconnect", Journal of Monetary Economics, 49(5),
pp. 913-940.
18
See Gopinath, G., Itskhoki, O., and R. Rigobon (2010), "Currency choice and exchange rate pass-through."
American Economic Review, 100 (1), pp. 304-36.
19
See Gräb, J., and R. Lafarguette (2015), "Differences in exchange rate pass-through in the euro area: The
role of currency invoicing". European Central Bank, mimeo, Frankfurt am Main.
and that the rise of participation in global value chains explains on average 40% of the fall in
the elasticity.20
Another feature that can alter the role of the exchange rate as a shock absorber is related to
the existence of global financial cycles. Some have suggested that rather than being driven
by the response to traditional demand and supply shocks, exchange rates react to shocks to
the leverage and risk appetite of financial intermediaries.21 As a result, exchange rates are
largely determined by capital flows unrelated to fundamentals and seldom act as shock
absorbers for the real economy. Others have even claimed that in major advanced
economies exchange rates are a source of macroeconomic fluctuations.22 For example,
Hyun Shin and co-authors have argued that exchange rates can contribute to the global
financial cycle by reducing the perceived credit risk in countries experiencing capital inflows,
only to precipitate crises when flows reverse and credit risk soars.23
Moreover, even the traditional trilemma arguing that exchange rate flexibility is a sufficient
condition for monetary policy autonomy under the assumption of globalised financial markets
is not as robust as we thought. Hélène Rey has recently argued that in the presence of
largely unrestricted capital flows driven by a global financial cycle, flexible exchange rates
are not a sufficient condition for monetary independence.24 As result, the 'trilemma' in
international macroeconomics may have grown smaller and become a dilemma. This, as
such, does not question the usefulness of flexible exchange rates. In a small open economy
where financial conditions are driven by a larger economy (the "centre"), exchange rate
adjustment can still mitigate the monetary policy reaction when the centre lifts its interest
rates up or down. But given the financial frictions likely to be involved, it cannot be taken for
granted that monetary policy will be fully insulated.
These insights lead me to ask the following question: do freely floating exchange rates along
with largely unrestricted capital flows still provide the basis for a well-functioning international
monetary system? I don't intend to provide an answer today. I know very well that when it
comes to the Marshall-Lerner elasticities, the devil lies in the econometric details, and I
acknowledge that exchange rate adjustment has served us well in many instances, allowing
monetary policies to adjust to national circumstances. Neither do I underestimate the
difficulties in a world of nation-states of altering the parameters of the current system. But
whether the shock absorbing role of exchange rates can be taken for granted is a question
we should all reflect on. It is clear to me that there is much more about the functioning of the
international monetary system that we need to understand. It's another field in which we as
policymakers, once again, depend on you as researchers.
Importantly, this discussion suggests that a frequently heard explanation for the challenges
facing the euro area - that its participating economies are suffering from having given up
exchange rate flexibility - may be too simplistic. Indeed, it is worth remembering that
monetary union was created precisely because cycles of repeated devaluations did not yield
macroeconomic stability, and that was in a world of less intense capital flows. Indeed, as
20
See Ahmed et al. (2015), "Depreciations without exports: Global value chains and the exchange rate elasticity
of exports", World Bank Policy Research Working Paper 7390; see also the IMF World Economic Outlook
2015, October, chapter 3.
21
See Maggiori, M., and X. Gabaix (2015), "International Liquidity and Exchange Rate Dynamics". Quarterly
Journal of Economics, 3, pp. 1369-1420.
22
See Farrant, K., and G. Peersman (2006), "Is the Exchange Rate a Shock Absorber or a Source of Shocks?
New Empirical Evidence". Journal of Money, Credit and Banking, 38, pp. 939-961.
23
See Bruno, V., and H.S. Shin (2015), "Cross-Border Banking and Global Liquidity". Review of Economic
Studies, 82(2), pp. 535-564.
24
See Rey, H. (2013), "Dilemma not trilemma: The global financial cycle and monetary policy independence". In:
Jackson Hole Economic Symposium 2013.
Charles Engel and co-authors have argued, there is little evidence that real exchange rates
under floating rates adjust in a desirable way. And a currency union can actually deliver a
superior performance, because it reduces the deviations from price equality for traded goods
that can occur under a floating regime.25 Still, for that to hold, the ability to engineer internal
devaluation is crucial. And that is another reason why a better understanding of the impact of
the nature and sequence of structural reforms in the euro area is crucial.
Financial globalisation: the paradox of integration
Like the debate on the role of exchange rates, the discussion about the benefits and possible
costs of financial integration has become more nuanced over time.
Conventional theory predicts that international financial integration fosters growth by allowing
for a more efficient global allocation of capital, by facilitating organisational and technological
spillovers across economies, and by boosting domestic financial market development. And it
should also allow for greater international risk-sharing and specialisation, thereby providing
an automatic stabilisation tool. The years since the emergence of financial globalisation,
however, have shown that it can also magnify spillovers and spillbacks, creating risks of
financial instability, that interfere with central banks' mandates. The exact balance of these
effects is, unfortunately, still unclear.
A very large body of empirical work - both at the macro- and micro-level - has been devoted
to the effects of international financial integration on growth and risk-sharing. The literature
has examined the issue by looking for gains following episodes of financial account
liberalisation and by computing the gains arising from a shift from autarky to integrated
financial markets in theoretical international macroeconomic models. Both strands of
literature, however, have in my view failed to deliver conclusive results. That is likely to be for
several reasons.
First, it might well be that the improved capital allocation across countries implies only a
small increase in output.26 Indeed, in theoretical models the gains from international financial
integration have been found to be relatively small. The intuition is that imperfect capital
mobility represents only a transitory distortion that delays, but does not hinder the
convergence to a long-run equilibrium with higher capital.27
Second, as in the domestic finance and growth literature28, some have argued that
nonlinearities play an important role: only if economies have reached a minimum level of
25
See Berka, M., Devereux, M., and C. Engel (2012), "Real Exchange Rate Adjustment in and out of the
Eurozone". American Economic Review: Papers and Proceedings, 102(3), pp. 179-185.
26
See Obstfeld, M. (2009), "International Finance and Growth in Developing Countries: What Have We
Learned?," IMF staff papers 56.; Van Wincoop, E. "Welfare Gains from International Risk Sharing," Journal of
Monetary Economics, 1994, 34, pp. 175-200 ; Van Wincoop, E. (1999), "How Big are Potential Welfare Gains
from International Risk Sharing?," Journal of International Economics, 47(1), pp. 109-135 ; Lewis, K. (1999),
"Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, 37, pp. 571-608;
Lewis, K. (2000), "Why Do Stocks and Consumption Imply such Different Gains from International Risk
Sharing?," Journal of International Economics 52, pp. 1-35; Lewis, K., and E. Liu (2014), "Evaluating
International Consumption Risk Sharing Gains: An Asset Return View," Journal of Monetary Economics, 71,
pp. 84-98.
27
See Gourinchas, P.-O., and O. Jeanne (2006), "The Elusive Gains from International Financial Integration."
Review of Economic Studies, 73, pp. 715-741 ; Coeurdacier, N., Rey H. and P. Winant (2013), "Financial
Integration and Growth in a Risky World," mimeo; Other authors find larger gains if capital goods are imperfect
substitutes, see Hoxha, I., Kalemli-Ozcan, S. and D. Vollrath (2013), "How Big Are the Gains from
International Financial Integration?," Journal of Development Economics Volume 103, pp. 90-98.
28
See Coeuré, B. (2014), "On the optimal size of the financial sector," speech at the ECB Conference, Frankfurt,
2 September. See also Beck, T., Degryse, H. and C. Kneer (2014), "Is More Finance Better? Disentangling
Intermediation and Size Effects of Financial Systems", Journal of Financial Stability, 10(C), pp. 50-64. Beck,
R., Georgiadis, G. and R. Straub (2014), "k' Finance and Growth Nexus Revisited", Economics Letters,
financial and institutional development that allows them to cope with possible swings in
capital flows, and to allocate large influxes of capital efficiently, can they reap the benefits of
international financial integration.29 Specifically, in the absence of developed and
wellregulated domestic financial markets, foreign short-term funding may be used for inefficient
borrowing, leading to excessive domestic credit cycles and even financial crises.30 The euro
area banking system is a case in point: the fragmentation of domestic money markets may
have led to an excessive reliance on dollar funding before the crisis, ending in a sudden stop.
Indeed, if one only considers economies with relatively sound institutions, there does appear
to be a positive relationship between international financial integration and growth.31
This previously discussed global credit cycles are also relevant to policymakers' perception
of financial globalisation. In particular, i