Since the seventies of the twentieth century, financial liberalization has prevailed, many countries have begun to promote financial opening, the scale of cross-border capital flows has grown rapidly, and many new characteristics have emerged in macroeconomic and financial operations under the conditions of opening up. At the same time, financial turmoil has occurred in some countries and regions, and financial crises around the world have also occurred frequently.
Traditional economyTheoryThe explanatory power is clearly insufficient
In view of these phenomena, the explanatory power of traditional economic theories is obviously insufficient, so a number of new economic theories have been born, such as the financial instability hypothesis, the currency crisis theory, the triadic paradox, the binary paradox and the global financial cycle theory.
It provides theoretical support for the impact of cross-border capital flows on financial stability in the following article. In a narrow sense, financial vulnerability refers to the innate characteristics of financial institutions and enterprises, such as the high-debt business model of financial institutions and enterprises, and the maturity conversion function of financial institutions, which make them more prone to risks, which is also known as financial intrinsic vulnerability, emphasizing that vulnerability is a natural feature of the financial system.
The concept of financial vulnerability in a broad sense is now more commonly used, that is, financial vulnerability generally refers to the financial system tends to a high-risk state, covering the generation and accumulation of risks in all financial fields. Against the backdrop of repeated financial crises around the world, scholars have begun to shift their thinking and try to explain financial crises in terms of the fragility of the financial system itself.
The theory of financial vulnerability came into being. The theory of financial vulnerability originated from the discussion of monetary vulnerability, and Fisher began to study the mechanism of financial vulnerability in depth earlier, and he explained the vulnerability of the financial system from the perspective of the economic cycle, thus proposing the debt-deflationary theory. Early theories focused on analyzing the correlation between financial vulnerabilities and the real economy.
Since then, the effects of the economic cycle have been gradually diluted, and it is generally accepted that financial vulnerabilities will occur under external shocks or endogenously, even without the role of the real economy. At present, the most representative of financial vulnerability theories are the financial instability hypothesis and the security boundary theory, the difference between the two is that the former is from the perspective of the firm, and the latter focuses on the perspective of the bank.
The real research on financial vulnerability began with Minsky, who systematically elaborated on the inherent vulnerability of finance from the perspective of enterprises and formed the "financial instability hypothesis". The hypothesis is based on the idea that when the economy is in a boom phase, interest rates are relatively low, financing conditions are relatively loose, and firms have higher expected returns and are motivated to invest more.
The asset bubble has also expanded rapidly, the speculative atmosphere in the market has become stronger, there are more and more speculative and Ponzi enterprises, the proportion of hedging companies has declined, financial vulnerabilities have become more and more serious, and the inherent instability of the financial system has increased. At this time, the policy authorities will tighten monetary policy for safety reasons, and the rise in interest rates will increase the debt service burden of companies.
It is very easy to cause debt default and even corporate bankruptcy, the non-performing loan ratio of financial institutions has risen rapidly, and the bubble of financial assets has burst rapidly, which not only threatens the stability of the financial system, but also may break out of the financial crisis. Kregel proposes the "security boundary theory" from the bank's point of view, which better explains Minsky's hypothesis of financial instability.
The safety boundary can be understood as the risk premium charged by the bank to the borrower, which is included in the borrower's loan interest. The theory is that although financial institutions are familiar with their competitors and the overall market environment, they are not able to make accurate predictions** about future market conditions, so banks still follow the Morgan Rule to make credit decisions.
That is, to estimate the safety boundary with reference to the borrower's credit history and decide whether to lend, without paying much attention to the expectations of the future.
Standards for security perimeters
During periods of sustained economic prosperity, borrowers tend to have good credit histories, and as a result, the standard of the security boundary is gradually lowered, leading to increasing vulnerability in the financial system when the security boundary is minimized.
If the economy deviates slightly from expectations, borrowers are likely to defer debt payments, borrow new loans to repay old loans, or even sell off assets, and there is a possibility of a debt-deflationary process described by Fisher. Through the continuous and in-depth exploration of financial vulnerability, information asymmetry, asset volatility and financial liberalization are recognized as the root causes of financial vulnerability.
Stiglitz and Weiss point out that it is the moral hazard and adverse selection between banks and corporate and depositors that information asymmetry leads to internal vulnerabilities in financial institutions. Under the effect of information asymmetry, there is always adverse selection and improper incentives in the market.
In times of economic prosperity, financial institutions often tend to invest in riskier projects with greater returns, and when the economic situation reverses, financial institutions will suffer huge losses, and once depositors capture this information, they will be very vulnerable to a run on the market, which will jeopardize financial stability. In addition, the existence of a deposit insurance system would allow depositors to relax their supervision of banks.
At the same time, it stimulates the excessive risk-taking of banks, and also exacerbates the fragility of the financial system, the vulnerability of the financial market mainly stems from the excessive volatility of assets and the resonance effect of fluctuations.
When market expectations are reversed, it will lead to a ** collapse and pose a threat to the stability of financial markets. **The main reasons for excessive volatility are macroeconomic instability, excessive speculation due to collective irrational behavior of the market, and the incomplete efficiency of the market.
At present, the fluctuation of financial assets has a strong resonance correlation characteristic, especially in today's highly integrated global economy and finance, the fluctuation of the financial market is easy to produce cross-market and cross-border contagion through multiple channels, and financial vulnerabilities are also easy to spill over from a single country to other countries.
Increased volatility of exchange rates also reinforces the vulnerability of financial markets, which occurs when economic fundamentals do not account for the magnitude of exchange rate fluctuations.
Excessive fluctuation of the exchange rate under the floating exchange rate system is a common phenomenon, and the exchange rate overshoot theory proposed by Dornbush believes that external shocks are an important part of the excessive fluctuations of the exchange rate under the floating exchange rate system, and the expectations of market players change under the external shocks, which in turn causes large fluctuations in the exchange rate.
However, the excessive fluctuation of the exchange rate is not a phenomenon only under the floating exchange rate system, in the fixed exchange rate system, when a currency crisis occurs, a country's exchange rate will have a huge adjustment pressure, driven by herd behavior and herd mentality, a huge amount of international speculative funds to attack a country's currency, will also greatly increase the fluctuation range of the exchange rate.
The intermediate exchange rate system will also bring financial vulnerability, under the pegged exchange rate system, enterprises and commercial banks will hold more unhedged external debt, foreign exchange risk increases, when the market is expected to reverse or the economic situation turns downward, international speculation will launch an attack resulting in the exchange rate, at this time the external debt pressure of enterprises and banks increases, and financial vulnerability is fully exposed. Financial liberalization can exacerbate financial vulnerabilities
It can be said that financial liberalization strengthens the inherent vulnerability of the financial system to a certain extent, exposing the inherent instability and risks of the financial system, as is the case with the Asian financial crisis in 1997.
After the Southeast Asian financial crisis, the international community began to pay close attention to the risks and financial vulnerabilities brought about by cross-border capital flows, and the financial vulnerabilities aggravated by cross-border capital flows were mainly manifested in excessive exchange rate fluctuations.
monetary policy failures and exacerbated risk contagion. Under the conditions of an open economy, financial vulnerabilities will be further amplified by cross-border capital flows, and foreign exchange risks will also arise when domestic banks borrow foreign currency from the international financial market and lend to domestic economic entities to fund high-risk projects, and unhedged foreign exchange risks can easily be converted into credit risks.
With the same security boundary, financing structures with a high proportion of foreign currency debt are clearly more volatile. With the rise of international institutional investors, a large number of speculative cross-border capital is fast in and out, which will not only form asset bubbles at a faster rate, but also cause asset bubbles to burst instantly, causing huge turbulence in the financial market.
The impact of cross-border capital flows will also bring about irregular fluctuations in exchange rates, which will also exacerbate financial vulnerabilities and easily trigger currency crises or even financial crises. For some countries with floating exchange rate regimes, the free flow of cross-border capital also limits a country's ability to formulate monetary policy independently, making it more difficult to regulate and control.
Cross-border capital flows have accelerated the accumulation of financial vulnerabilities and the exposure of inherent instability in the financial system, prompting more frequent financial crises. According to Minsky, the state can adopt a "big" and "big-bank" approach to alleviate financial vulnerabilities, and intervention in the economy is necessary.
However, under the conditions of openness, the goal of stabilizing the exchange rate can become a constraint, and financial openness weakens the policy effectiveness of monetary and fiscal policies,** and the policy means of maintaining internal and external equilibrium are more limited, thus making cross-border capital flows more difficult for some countries to withstand financial crises.
In the seventies of the 20th century, the trend of financial liberalization began to rise, and international capital was gradually able to flow freely, at the same time, the Bretton Woods system collapsed, the exchange rate system pegged to the US dollar collapsed, and currency crises occurred frequently around the world.
After in-depth analysis of the causes and transmission mechanisms of previous currency crises, the theory of currency crisis has been continuously developed and improved, and three generations of mature currency crisis theory have been formed so far.
The theory of currency crisis mainly describes that for countries that implement a fixed exchange rate system, when market players lose confidence in their currencies and sell their currencies in large quantities, they are forced to abandon the fixed exchange rate system because they cannot maintain the stability of their own currency exchange rates due to limited foreign exchange reserves. The basis of the first-generation currency crisis theory is the balance of payments crisis model proposed by Krugman, the core idea of which is that the root cause of the currency crisis is that the macroeconomic policies adopted are inconsistent with the goal of maintaining a fixed exchange rate system, and the imbalance of economic fundamentals is the leading factor in the occurrence of currency crises.
The first-generation currency crisis theory assumes that the demand for money in an economy remains unchanged and that the money supply is the sum of domestic credit and foreign exchange reserves, and when a country's economic fundamentals deteriorate, expansionary fiscal policy will be implemented to stimulate the economy, and the fiscal deficit will be covered by the issuance of money, resulting in a continuous increase in the scale of domestic credit.
In order to maintain the fixed exchange rate system, banks can only use foreign exchange reserves, and the scale of foreign exchange reserves continues to decrease.
Conclusion
Due to the limited foreign exchange reserves, the practice of maintaining exchange rate stability through foreign exchange intervention was not sustainable, and eventually the country had to abandon the fixed exchange rate system, and the local currency depreciated sharply, and the currency crisis erupted. In particular, when foreign exchange reserves are about to be exhausted, international speculators will carry out speculative attacks on the country's currency, causing massive capital flight and accelerating the realization of a currency crisis.