That is the impact of financial integration and how to deal with cross-border capital flows. Over the past two decades, the level of financial integration across countries has increased rapidly. If we take the total stock of external assets and liabilities relative to world GDP as a gauge of financial integration, in 1980 this stood at around a quarter, roughly equal to the ratio of global trade to world output. By 2010, global finance was nine times global trade. For emerging and developing countries, gross international assets and liabilities have increased by more than fivefold in the past ten years alone. For advanced economies, the expansion has been even more rapid. Accompanying the trend increase in financial integration has been a large expansion in gross capital flows as well as an increase in the volatility of those flows. Periods of synchronized asset price volatility across countries and regions have become more prevalent. There is increasing talk of a global financial cycle driven, in part, by US monetary policy. This has led to an active debate about the impact of financial integration on individual countries’ ability to manage domestic financial conditions. Does increased financial integration limit the effectiveness of monetary control? How should countries respond to increased capital flows? Is there room for policy coordination? Let me say at the outset that there are no clear cut solutions. There is a large academic literature that discusses the pros and cons of various instruments, such as capital controls and macroprudential measures. I will not discuss these at length.

Lately, the “dark side” of financial integration has increasingly come into focus. The global financial crisis was a vivid demonstration of what happens when the system flips over from stable to instability. And the prescribed treatment has created increasingly serious side-effects ever since. With monetary policy in advanced economies having been kept at ultra loose levels for over 5 years and still further unconventional monetary stimulus being embarked upon in some cases, the repercussions on the rest of the world are testing the limits of macroeconomic management, especially for emerging market countries. Large capital inflows have lowered long-term yields and compressed risk spreads across a wide range of asset classes, contributing to increased risk-taking. The marked rise in the co-movement of asset prices across countries, particularly in bond yields, is making it harder for policies to achieve desired financial conditions domestically. At the same time, upward pressure on exchange rates risks undermining export competitiveness, complicating the trade-offs between macroeconomic stabilization and financial stability. And should inflows reverse abruptly, the resulting asset price and exchange rate swings could induce broad contagion effects that prove disruptive to economic activity. In all this, the underlying concern is that integration has amplified the vulnerability of domestic financial conditions to external shocks, while limiting the effectiveness of the tools that policymakers have for addressing those shocks. This is not solely an emerging market problem. Indeed, the degree of co-movement in bond yields appears to be even stronger for advanced economies.