Does Financial Globalization Discipline Macroeconomic Policies

Using the unbalanced panel data of 160 countries from 1970 to 2007, we employ inflation and the budget deficit as proxies for monetary policy and fiscal policy, respectively, and study whether financial globalization has discipline effects on these macroeconomic policies. The empirical results in our study suggest a significant discipline effect of financial globalization on monetary policy during the entire sample period, which is robust both to de jure and to de facto measures of financial openness. Our sub-sample investigations demonstrate that financial globalization reduces inflation only in higher-middle-income and high-income countries, and when financial globalization is scaled by the proportion of a country’s foreign assets and liabilities to its GDP, the discipline is evident only after 1988. Nevertheless, we do not demonstrate any evidence of financial globalization’s discipline effect on fiscal policy. The empirical results indicate that financial globalization even increases the budget deficit in certain countries and periods.