On this run of history, the global flow of funds could become an increasingly powerful generator of global financial instabilities. In that event, pressures could mount on policymakers to protect against the rising tide of capital flow-induced instability, including through capital restrictions and macro-prudential measures. Some of these measures, if not unthinkable, would have been frowned on as recently as a decade ago. When Malaysia imposed restrictions on capital movements in 1998, it was castigated by the international community. And when the Hong Kong authorities intervened in their stock market in the same year, many international policymakers blew a raspberry. What a difference a decade makes. What a difference a crisis in advanced economies makes. Ideological aversion to throwing grit in the wheels of international finance appears, if not to have disappeared, then to have moderated. Where once it was raspberries, today’s policymakers are blowing kisses. Capital restrictions and macro-prudential policies have entered the policy bloodstream, if not yet the mainstream. The debate today is how best to integrate such tools into established macroeconomic policy frameworks. The issues here are thorny ones. They include:   Should capital restrictions be used by emerging markets as a last resort once conventional macroeconomic policies have been exhausted? Or should they instead play a supporting role in all seasons, to avert excessive capital surges and accompanying fluctuations in financial activity? And what guidelines, if any, should apply to the policies of advanced countries as the source of such capital surges?

A reduction in those capital market frictions would tend to lower the asset market spillover costs of the BFSP problem.   Finally, what guideposts should be provided by the international community in tackling the BFSP problem? The IMF recently began to explore such a framework (IMF (2011)). This raises a set of key questions about global financial governance. Are global financial network externalities sufficiently large to justify the international community imposing rules of the financial road? And how much driver discretion should instead be left to nation states which ultimately may bear the costs of the BFSP problem? These are big public policy questions. They are by no means new ones. If the quantitative experiments presented here are even roughly right, these questions may assume a new urgency in the period ahead. The BFSP problem is real. It may be rising. The result would be growing waves of global financial exuberance, punctuated by crashing capital busts. This roller-coaster has the potential to leave some nation states feeling queasy. They may even wish to get off. What is at stake may be more than just the future stability of the international financial system. References Barro, R J and Sala-i-Martin, X (1992), “Convergence”, Journal of Political Economy, Vol. 100 (2) pages 223–251. Dornbusch, R, Goldfajn, I and Valdés, R (1995), “Currency Crises and Collapses”, Brookings Papers on Economic Activity, Vol. 26(2), pages 219–294. French, K R and Poterba, J M (1991), “Investor Diversification and International Equity Markets”, American Economic Review, Vol. 81 (2), pages 222–226.