Capital Market Liberalization and Exchange Rate Regimes: Risk without Reward

Abstract

This paper examines the consequences of capital market liberalization, with special reference to its effects under different exchange rate regimes. Capital market liberalization has not lead to faster growth in developing countries, but has led to greater risks. It describes how International Monetary Fund policies have exacerbated the risks, as a result of the macro-economic response to crises, with bail-out packages that have intensified moral hazard problems. The paper provides a critique of the arguments for capital market liberalization. It argues that capital flows give rise to large externalities, which affect others than the borrower and lender, and whenever there are large externalities, there is potential scope for government interventions, some of which are welfare increasing.

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