Financial Integration, Economic Growth and Financial Stability

Financial integration is a strong and growing force shaping the international economic landscape. This research group analyses the role of financial integration for economic growth and financial stability.

Neoclassical economics suggest that an integrated global financial market can boost economic growth through reduced capital costs and increased risk-sharing. However, countries with a liberalised capital account in fact do not necessarily perform better than economies with capital controls, and the last global financial crisis caused a reversal to the process of financial globalisation. Therefore, reevaluating the role of financial integration for economic growth and financial stability is of great importance for policy discussion as well as academic research.

This research group aims at finding answers to the following questions: First, the group investigates how the productivity of firms is affected by the access to international capital and whether capital-intensive sectors benefit more from capital account liberalisation than other sectors. In addition, this group explores the structural transformational consequences of financial integration. Second, international capital is fueled into the economy through financial institutions. The group analyses whether the cross-border capital flow alternates banks’ behaviour and specifically, how the financing maturity, structure and systemic risk are affected. Third, international organisations like the IMF suggested a gradual path to liberalise the capital account, the main idea of which is to liberalise the inward flow before the flow out, and the FDI flow before the flow of debt and equity. However, empirical evidence is rare. This group studies whether and how the sequencing of capital account liberalisation matters for financial stability.

Research Cluster
Productivity and Institutions

Your contact

Professor Xiang Li, PhD
Professor Xiang Li, PhD
Mitglied - Department Macroeconomics
Send Message +49 345 7753-805 Personal page

Refereed Publications

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Surges and Instability: The Maturity Shortening Channel

Xiang Li Dan Su

in: Journal of International Economics, forthcoming

Abstract

Capital inflow surges destabilize the economy through a maturity shortening mechanism. The underlying reason is that firms have incentives to redeem their debt on demand to accommodate the potential liquidity needs of global investors, which makes international borrowing endogenously fragile. Based on a theoretical model and empirical evidence at both the firm and macro levels, our main findings are twofold. First, a significant association exists between surges and shortened corporate debt maturity, especially for firms with foreign bank relationships and higher redeployability. Second, the probability of a crisis following surges with a flattened yield curve is significantly higher than that following surges without one. Our study suggests that debt maturity is the key to understand the financial instability consequences of capital inflow bonanzas.

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Total Factor Productivity Growth at the Firm-level: The Effects of Capital Account Liberalization

Xiang Li Dan Su

in: Journal of International Economics, forthcoming

Abstract

This study provides firm-level evidence on the effect of capital account liberalization on total factor productivity (TFP) growth. We find that a one standard deviation increase in the capital account openness indicator constructed by Fernández et al. (2016) is significantly associated with a 0.18 standard deviation increase in firms’ TFP growth rates. The productivity-enhancing effects are stronger for sectors with higher external finance dependence and capital-skill complementarity, and are persistent five years after liberalization. Moreover, we show that potential transmission mechanisms include improved financing conditions, greater skilled labor utilization, and technology upgrades. Finally, we document heterogeneous effects across firm size and tradability, and threshold effects with respect to the country's institutional quality.

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Financial Technologies and the Effectiveness of Monetary Policy Transmission

Iftekhar Hasan Boreum Kwak Xiang Li

in: European Economic Review, January 2024

Abstract

This study investigates whether and how financial technologies (FinTech) influence the effectiveness of monetary policy transmission. We use an interacted panel vector autoregression model to explore how the effects of monetary policy shocks change with regional-level FinTech adoption. Results indicate that FinTech adoption generally mitigates the transmission of monetary policy to real GDP, consumer prices, bank loans, and housing prices, with the most significant impact observed in the weakened transmission to bank loan growth. The relaxed financial constraints, regulatory arbitrage, and intensified competition are the possible mechanisms underlying the mitigated transmission.

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Household Indebtedness, Financial Frictions and the Transmission of Monetary Policy to Consumption: Evidence from China

Michael Funke Xiang Li Doudou Zhong

in: Emerging Markets Review, June 2023

Abstract

This paper studies the impact of household indebtedness on the transmission of monetary policy to consumption using the Chinese household-level survey data. We employ a panel smooth transition regression model to investigate the non-linear role of indebtedness. We find that housing-related indebtedness weakens the monetary policy transmission, and this effect is non-linear as there is a much larger counteraction of consumption in response to monetary policy shocks when household indebtedness increases from a low level rather than from a high level. Moreover, the weakened monetary policy transmission from indebtedness is stronger in urban households than in rural households. This can be explained by the investment good characteristic of real estate in China.

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Does Capital Account Liberalization Affect Income Inequality?

Xiang Li Dan Su

in: Oxford Bulletin of Economics and Statistics, No. 2, 2021

Abstract

By adopting an identification strategy of difference‐in‐difference estimation combined with propensity score matching between liberalized and closed countries, this paper provides robust evidence that opening the capital account is associated with an increase in income inequality in developing countries. Specifically, capital account liberalization, in the long run, is associated with a reduction in the income share of the poorest half by 2.66–3.79% points and an increase in that of the richest 10% by 5.19–8.76% points. Moreover, directions and categories of capital account liberalization matter. The relationship is more pronounced when liberalizing inward and equity capital flows.

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Working Papers

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Technological Innovation and the Bank Lending Channel of Monetary Policy Transmission

Iftekhar Hasan Xiang Li Tuomas Takalo

in: IWH Discussion Papers, No. 14, 2021

Abstract

This paper studies whether and how banks’ technological innovations affect the bank lending channel of monetary policy transmission. We first provide a theoretical model in which banks’ technological innovation relaxes firms’ earning-based borrowing constraints and thereby enlarges the response of banks’ lending to monetary policy changes. To test the empirical implications, we construct a patent-based measurement of bank-level technological innovation, which can specify the nature of technology and tell whether it is related to the bank’s lending business. We find that lending-related innovations significantly strengthen the transmission of the bank lending channel.

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Dilemma and Global Financial Cycle: Evidence from Capital Account Liberalisation Episodes

Xiang Li

in: IWH Discussion Papers, No. 13, 2021

Abstract

By focusing on the episodes of substantial capital account liberalisation and adopting a new methodology, this paper provides new evidence on the dilemma and global financial cycle theory. I first identify the capital account liberalisation episodes for 95 countries from 1970 to 2016, and then employ an augmented inverse propensity score weighted (AIPW) estimator to calculate the average treatment effect (ATE) of opening capital account on the interest rate comovements with the core country. Results show that opening capital account causes a country to lose its monetary policy independence, and a floating exchange rate regime cannot shield this effect. Moreover, the impact is stronger when liberalising outward and banking flows.

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China’s Monetary Policy Communication: Frameworks, Impact, and Recommendations

Michael McMahon Alfred Schipke Xiang Li

in: IMF Working Paper No. 18/244, 2018

Abstract

Financial markets are eager for any signal of monetary policy from the People’s Bank of China (PBC). The importance of effective monetary policy communication will only increase as China continues to liberalize its financial system and open its economy. This paper discusses the country’s unique institutional setup and empirically analyzes the impact on financial markets of the PBC’s main communication channels, including a novel communication channel. The results suggest that there has been significant progress but that PBC communication is still evolving toward the level of other major economies. The paper recommends medium-term policy reforms and reforms that can be adopted quickly.

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Within Gain, Structural Pain: Capital Account Liberalization and Economic Growth

Xiang Li Dan Su

in: New Structural Economics Working Paper No. E2018010, 2018

Abstract

This paper is the first to study the effects of capital account liberalization on structural transformation and compare the contribution of within term and structural term to economic growth. We use a 10-sector-level productivity dataset to decomposes the effects of opening capital account on within-sector productivity growth and cross-sector structural transformation. We find that opening capital account is associated with labor productivity and employment share increment in sectors with higher human capital intensity and external financial dependence, as well as non-tradable sectors. But it results in a growth-reducing structural transformation by directing labor into sectors with lower productivity. Moreover, in the ten years after capital account liberalization, the contribution share of structural transformation decreases while that of within productivity growth increases. We conclude that the relationship between capital account liberalization and economic growth is within gain and structural pain.

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