Financial Liberalization and Tests of Capital Flow Mobility in Taiwan

Abstract

Taiwan's financial policies played a vital role in promoting its relatively rapid post-war industrialization, a process that involved the use of different financial strategies to accommodate different stages of economic development. This paper aims to examine the process of Taiwan's financial liberalization and the relationship of this process to the opening up of Taiwan's capital account, which can be viewed as the last reform stage for the entire financial liberalization process. The first section briefly introduces the evolution of Taiwan's financial policies during different stages of development, giving primary focus to her efforts at financial liberalization starting in the 1980s. During this period, mid-1987, the time when Taiwan's government promulgated a new law to deregulate foreign exchange control, counts as a watershed for Taiwan's exchange rate market. The second section uses the conventional interest rate parity method to compare the extent of capital flow mobility before and after mid-1987. The results of the comparison show only a slight improvement in capital flow mobility after mid-1987. The author argues that the interest rate parity method may, for various reasons, be inadequate for testing capital mobility in Taiwan's case. Evidence, in the form of measures that the Taiwan's government has taken over time as described in the first section and Appendix, shows that Taiwan's financial markets have become increasingly open and more market-oriented as the financial liberalization process progresses. Although the government is still intervening in both interest rate and exchange rate markets, the trend is toward less intervention, except for a brief period during the 1998-99 Asian Financial Crisis. The final section presents a brief conclusion and directions for further research.