Capital Account Liberalization and Policy Incentives: An Endogenous Policy View

Abstract

The view that capital flows are typically exogenous destabilizing factors suggests the need for heavy regulation of financial flows. Another view, that capital flows are largely rational, endogenous responses to underlying conditions, suggests that policies, rather than market responses, are disruptive. It is not surprising that policy officials tend to incline toward the first view. It is argued that the evidence suggests that the explanatory power of the second view is greater, although identification of the fundamental cause of capital flows in a particular time and place is always uncertain. The distinction between exogenous and endogenous factors also suggests an important role that international capital flows can play in helping to generate more stable and efficiency-increasing economic policies.

JEL Classification: F32, F39, F41