Does deeper financial integration lead to macroeconomic and financial instability in Asia?

Abstract

Even though a deeper financial integration and higher economic and financial stability are the prime goals of many Asian policymakers, no researcher has studied the relationship between integration and (in)stability in Asia. To fill this gap in the literature, this paper investigates the causality between financial integration and macroeconomic and financial instability. To this end, we use the Generalized Method of Moments to estimate a set of dynamic panel data models for a block of Asian countries over the period 2000–2017. Our estimation results show that there is a bidirectional causal relationship between financial integration and instability in Asia. Moreover, we find that financial integration causes instability in output and credit markets. The overall results show that macroeconomic and financial instability in Asia leads to financial disintegration. More specifically, the volatilities of the exchange rate and output growth cause financial fragmentation. Furthermore, we underscore the role of coordinated fiscal and monetary policies in offsetting the adverse effect of financial integration on macroeconomic and financial stability in Asia. Finally, the global financial crisis of 2008 has increased financial disintegration and instability in Asia. Our findings might help Asian policymakers to choose their policy targets when integrating into the global financial system.