With Global Financial Markets, How Much Control Do Countries Have Over Economic Policies?
IMF Blog, April 6, 2017
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Bibliographic details
- Authors: Selim Ali Elekdag, Gaston Gelos
- Published: April 6, 2017
Overview
- Publication: Selim Ali Elekdag, Gaston Gelos
- Date: April 6, 2017
- Core question: In an increasingly integrated global financial system, how much control do countries outside of the US retain over their economic policies?
Key findings
- Global events account for between 20 percent and 40 percent of local financial conditions across countries.
- Even as financial markets have become more integrated, the degree of control countries exert over domestic conditions has only diminished mildly over the past two decades.
- Global conditions appear to be strongly driven by the United States, in part because the dollar is the predominant currency in international transactions.
- The global financial conditions index correlates strongly with those in the United States and with the Chicago Board Options Exchange Volatility Index (VIX), a gauge of perceived risk in US equities.
- Emerging markets are more sensitive to global conditions than advanced economies.
- Rapid speed and strength by which external financial shocks affect local markets often makes it difficult for policymakers to react in a timely and effective manner.
Mechanism and example
- A US Federal Reserve decision to raise interest rates increases yields on US assets and attracts capital from other countries.
- Capital attraction can push up interest rates abroad, making credit more costly and constraining consumers and companies.
- Such an outcome can be unwelcome for countries aiming to keep borrowing costs low to combat unemployment or sustain economic growth.
Policy recommendations and resilience measures
- Emerging markets should take steps to bolster resilience to global shocks:
- Deepen domestic financial markets.
- Develop a local investor base to make markets less susceptible to fluctuations in cross-border capital flows.
- These steps are particularly important when financial conditions are tightening in response to the Fed’s rate hike.
Further analysis
- The IMF will release more analysis from the Global Financial Stability Report on April 19.
IMF blog post: With Global Financial Markets, How Much Control Do Countries Have Over Economic Policies? — April 6, 2017