The Theory And Practice Of Financial Stability In Open Economy

Financial integration and financial liberalization together with financial globalization are the three domain trends of today's financial market. At the same time the open economy has already become the inevitable choice of every economic entity. However the frequency of financial crisis since 1990s accompanied by the unpredictable volatility of financial market effects negatively the growth of world economy, even the political structure as well. At down of the 2l century, maintaining financial stability is thus a key objective of financial authorities. China has successfully gained her entry to WTO in last year, and will definitely involve in world economic and financial system in almost all respects. To maintain a higher economic growth and financial stability as well is her most important objective in the new century. The essay takes financial stability, the new but rigorous subject, as the focus of research and tries to form a frame of definition , theory, mechanism and policy system of it.The essay is composed of three parts of eight chapters except preface and concluding remarks, and each part is arranged as following. Chapter one through four comprises the first part, mainly viewing the definition, the theoretical explanation and mechanism of financial stability. At beginning of Chapter one, since there is no generally accepted definition of financial stability, I give my definition of financial stability as the stable functioning of the intermediaries and markets that make up the financial system, and it is quite different from monetary stability, bank soundness, financial crisis and the same etc. The classical economics such as "debt-liquidation theory" by Irving Fisher and "financial instability hypothesis " by Hyman Minsky does not provide rich set of paradigms for analyzing the nature and consequences of financial instability. The essay gives more emphasis on the insights from game theory and from the economics of decision making under uncertainty in explaining the behavioral mechanism of bank runs, non-performing loans and asset-price volatility, especially the volatility of foreign-exchange markets, equity markets and real estate and other asset market. And moreover the essay gives special analysis of the defaults of international payment and settlement arrangement, which is another important factor of international financial instability. Concerning the special functioning of banking, Chapter 2 concentrates on the soundness of bank, the core of financial stability. After theoretical analysis of bank runs using Diamond-Dybvig model, the essay discusses the indicators of banking distress, such as CAMELS and "prompt correction system" of America and Japan. Based on the above analysis several suggestions conclude. Chapter three and four are the theoretical and normal discussion about the relationship between financial liberalization and financial stability Being the core of financial liberalization, interest rate liberalization affects negatively the quality of bank assets and consequently the financial condition of banks on one hand. On the other hand liberalization of interest rate often follows by the volatility of asset prices. Other respects of financial liberalization including financial innovation and capital-flow liberalization also influence the functioning of financial institutions and volatility of financial asset price. As financial liberalization being criticized as the main cause of recent financial turmoil especially the South-east Asian crisis of 1997 , every economic entity concerns about how to maintain financial stability while involves deeply in the overwhelming liberalization trend, the essay takes Korea and China Taibei as two sample entities towards the financial liberalization but quite different consequences. By analyzing the detailed experience towards financial liberalization, the essay concludes that: financial liberalization and financial stability is absolutely no contradictious, but there is no ready path for any country to take, one must findhis own path which r...