It is widely recognized that financial market globalization has been developing. International financial markets have expanded substantially, and transaction volumes in foreign exchange markets and capital markets have increased markedly. Progress in information and telecommunications technologies, liberalization in capital markets, and development of new financial instruments have further stimulated international capital flows, leading to more expansion and efficiency in international financial markets.
However, empirical evidence suggests that national borders have been serving as some sort of barriers to international capital flows. Portfolios of investors based in industrialized countries are biased toward domestic assets (the "home bias puzzle" ), and national savings tend to be absorbed domestically (the "Feldstein-Horioka paradox" ). From a long-term historical perspective, the size of net capital flows has not increased so much.
Alternatively, such development of globalization can be viewed differently once we take account of other aspects such as off-balance sheet transactions. Derivative instruments offer the possibility of unbundling risks inherent in underlying assets, and such unbundled risks can be repackaged and dealt in separately. Thus, cross-border derivatives transactions enhance the effectiveness of risk transfer.
Given the recent growing trend toward financial globalization, how and at what pace financial globalization will develop in the future have important implications for the conduct of monetary policy by central banks. If financial markets become further integrated and international capital flows more actively, it is obvious that independent monetary policy directed toward domestic goals, liberalization of capital mobility, and fixed foreign exchange rates cannot be achieved simultaneously. In addition, prudential policy might face new problems pertaining to the stability of the financial system due to increasing international linkage among asset prices.
Keywords: Globalization; Central bank; International capital mobility; Risk diversification; Monetary policy; Stability of fiancial system
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.