International Finance

Changes have been evenmore dramatic in the realm of international finance than in international trade. The liberalization and integration of global financial markets began in the 1980s, but accelerated significantly in the 1990s. For example, data fromthe Bank for International Settlements indicate that global foreign exchange turnover increased fromU.S. $620 billion in 1990 to U.S. $3.2 trillion in 2007. Potential benefits that can emerge from these changes include improved resource allocation from countries specializing in financial services; increased portfolio diversification; improved competition in the financial sector; and increased market discipline on policymakers. Such changes can have positive effects on the overall growth and development of the countries involved. That said, these changes in the landscape of global finance have also been associated with repeated episodes of significant turbulence. For example, in 1992 93, Europe was faced with the very real possibility of a complete collapse of the European Exchange Rate Mechanism (ERM). In 1994 95, the Mexican currency crisis involved a steep devaluation of the peso and brought Mexico to the brink of default, with spillover effects on Argentina and Brazil. Between July 1997 and mid-1998, the world experienced the effects of the East Asian crisis, which started somewhat innocuouslywith a run on theThai baht, but spread swiftly to a number of other regional currencies, most notably the Indonesian rupiah, Malaysian ringgit, Philippine peso, and Koreanwon. Other large emerging economies, such as Russia and Brazil, also experienced periods of significantmarket weakness and required the assistance of the International Monetary Fund. The Russian ruble was devalued inAugust 1998,while theBrazilian real’sfixed rate to the U.S. dollar was eventually broken in January 1999. A number of other smaller emerging economies, such as Turkey and Ecuador, also experienced currency and financial crises in the 1990s. Another striking change has been the reversal of capital flows from developed to developing countries. Due in large part to the emergence of a significant current account deficit (i.e. spending in excess of national saving) in theUnited States and involving the official transactions of central banks, the developing world is now an exporter of capital to the developed world rather than an importer. In fact, the flow of international capital from developing countries to developed countries is now one of the key paradoxes of the global economy, as is the fact that foreign governments and central banks have become major participants in global financialmarkets via the creation of sovereign wealth funds. Finance-related entries in the Encyclopedia reflect these important changes. Standard models of international finance and open-economy macroeconomics are covered, including the interest parity conditions and theMundell-Flemingmodel, and a host of basic concepts such as balance of payments, capital flight, currency crisis, and sterilization. These are supplemented with more recent theoretical contributions such as the New Open Economy Macroeconomics. Entries on policy instruments include capital controls, hedging, and foreign exchange intervention, to name a few. Coverage also includes the basic analytical tools of the field, such as early warning systems and exchange rate forecasting, as well as special topics such as financial services, sequencing of financial sector reform, recycling of petrodollars, and money laundering.