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Abstract

This paper studies the different tradeoffs between growth and volatility by both sides of capital flows on the basis of their different considerations of financial risks and levels of financial development. Since growth and volatility are negatively correlated, volatility must be kept low to derive high growth from capital flows when integrating into global markets. The reason why one side´s push for capital market opening encounters the other side´s reluctance is that the former may likely benefit from openness while the latter is unsure abouth the gains from financial liberalization due to its financial market imperfections. This conflict of interest is resolved as a bargaining equilibrium by making each side´s optimal tradeoff internationally compatible. Bargaining between the two sides with differeing valuations of capital flows leads to information revelation through strategic delays in financial liberalization which explains the many stylized puzzles such as the Feldstein-Horioka puzzle.

Abstract

In this article, we develop an empirical framework to shwo the importance of money during the Great Moderation, while accounting for the fact that monetary policy was exlusively conducted through interest rates. We estimate the impulse response functions and forecast error variance decomposition derived from a structural VAR with a laest absolute shrinkage and selection operator-based lag selection. The variance decomposition suggests that a substantial component of macroeconomic variation has been driven by shocks to the money market, which were not only unintended by the Federal Reserve, but worse passed unnoticed allowing those shocks to accumlate over time.