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Most countries emerged from the Second World War with capital
accounts that were closed to the rest of the world. Since then, a
process of capital account opening has occurred, with the result
that all developed and many emerging-market countries now have
capital accounts that are both de facto and de jure open, while
many developing countries also have de facto openness. This study
examines this in part by considering some of the first lessons from
the current global financial crisis. This crisis may change the
terms of the debate on capital account liberalization in a deeper
and more lasting way than any of the crises of the past two decades
because it may mark a reversal in the secular trend of financial
liberalization at the core of the international financial system.
The current crisis also raises new questions about the appropriate
policy responses to boom-bust dynamics in domestic credit and in
international credit flows. Intellectual consistency is needed
between the domestic and international dimensions of financial
regulation and the policies aimed at dealing with boom-bust
dynamics in domestic and international credit.
What are the most damaging external shocks for countries at
different stages of development? What can countries do to protect
themselves against such disturbances? Real shocks (for example, to
the terms of trade) are the most important ones for developing
countries, but financial shocks (for instance, sudden stops) rank
highest for emerging market countries. "Country Insurance: The Role
of Domestic Policies" examines "self-insurance" policies whereby
countries can protect themselves - leaving to future work the role
of regional and multilateral arrangements. The main messages are
that countries need to adopt appropriate reserve buffers that take
into account their vulnerability to shocks - with the size of such
buffers quantified by region - and pursue policies, such as
longer-term domestic currency debt and foreign direct investment,
that secure less crisis-prone external liability structures.
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