Financial Liberalization : Deregulation Of Financial Markets And The Freedom Of Capital Mobility Across Economies

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Financial liberalization involves deregulation of financial markets and the freedom of capital mobility across economies. “Financial liberalization produces major benefits including more efficient intermediation of financial resources however it does have a ‘dark side’, because it produces a banking system that is more vulnerable to systemic risk” (Arthur Wilmarth Jr 2003). Periods of high international capital mobility have repeatedly produced international banking crises. “Kaminsky and Reinhart present evidence that the probability of a banking crisis conditional on financial liberalization having taken place is higher than the unconditional probability of a banking crisis” (Reinhart and Rogoff 2011). This is shown in figure 10.1…show more content…
According to B.E. Gup (2004), the same was true of the United States during the Great Depression; in response to varying competitive environments, federal authorities approved notably larger authority to banks during the start of the 20th century, for example in the securities market. “The U.S. conceit that its financial and regulatory system could withstand massive capital inflows on a sustained basis without any problems arguably laid the foundations for the global financial crisis of the late 2000s” (Reinhart and Rogoff 2011). The rational of ‘this time is different’ in the U.S. due to its superior structure was proved false. Financial and international capital account liberalization and the removal of barriers for investment opportunities have transpired globally since the early 1970s. When countries receive large amounts of foreign capital, an instant effect is an overheating economy due to an expansion of aggregate demand. As this inflow arrived into the United States, investment banks such as Goldman Sachs saw profits rocket. “The size of the U.S. financial sector more than doubled, from 4 percent in the mid 1970s to almost 8 percent of GDP by 2007” (Reinhart and Rogoff 2011). The frontrunners of the financial sector (who miscalculated the hidden risks involved in their own activity) were convinced that financial modernism was an important factor that allowed the U.S. to borrow such large amounts of money from abroad. According to

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