There is a long-standing debate on the benefits and drawbacks of financial globalization. Among the benefits, academics and practitioners emphasize that globalization causes capital to flow to its most attractive destination, increasing productivity and growth. Yet, since financial globalization spread around the world in the last three decades, many have argued that capital flows tend to be excessive and end up in crises. They also highlight that capital flows are mostly fueled by monetary policy in the financial center that lead to pro-cyclical policies in the periphery, triggering instability as well as inflationary pressures.

To understand the trade-offs of financial globalization, it is essential to also examine episodes of financial repression. This is what this study does. It evaluates the behavior of monetary policy, inflation, credibility of the policies of the central banks, and the evolution of the quality of institutions during both episodes of financial repression and globalization. This work focuses in Asia and Latin America over a period of 60 years.

Interestingly, the evidence from these countries indicates:

First, while capital inflows fuel inflation, inflation is far higher during episodes of financial repression. During financial repression, government deficits tend to be much higher and persistent. Central banks finance these deficits by lending to governments, with money supply increasing and fueling high chronic inflation. With domestic investors captive in the domestic financial sector, there is no pressure for governments and central banks to reduce deficits and money supply growth. In contrast with globalization, governments and central banks follow more stabilizing fiscal and monetary policies to attract both domestic and foreign investors.

Second, as monetary authorities tend to follow a more anti-inflationary stance during episodes of financial globalization, central banks’ credibility increases, pushing inflation even lower.

Third, globalization has been blamed for the loss of monetary policy independence and macroeconomic instability in the emerging periphery. It has also been argued that, with globalization, cycles of monetary easing and contracting in the financial centers trigger cyclical monetary policies in the periphery, thus exacerbating the underlying business cycle. In other words, when it rains, it pours. Yet, the evidence suggests that globalization has brought better institutions and policies to developing economies. Many emerging market countries are now following countercyclical monetary policies, and their results indicate that with better institutions, central banks have beenable to overcome the fear of floating and are using policy interest rates for countercyclical purposes.

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Graciela L. Kaminsky is professor of Economics and International Affairs at George Washington University and Research Associate at the National Bureau of Economic Research. She previously held positions as assistant professor at the University of California, San Diego and staff economist at the Board of Governors of the Federal Reserve System. She has been a Visiting Scholar at numerous government organizations, including the Bank of Japan, the Bank of Spain, the Federal Reserve Bank of New York, the Hong Kong Monetary, and the Monetary Authority of Singapore. She has also been a consultant to international institutions, including the Inter-American Development Bank, the International Monetary Fund, and the World Bank. She holds a Ph.D. in Economics from MIT.

Professor Kaminsky has published widely in leading academic journals, including American Economic Review, Journal of Development Economics, Journal of International Economics, Journal of Monetary Economics, and Journal of Economic Perspectives. Her research has been featured in the financial press, including The Economist, The Financial Times, and Business Week. Professor Kaminsky's research covers a variety of topics in macroeconomics and international finance, including financial globalization, mutual fund's investment strategy, currency and banking crises, contagion, credibility, and inflation stabilization policies.

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