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Mark M. Spiegel is Vice President, Economic Research, and Director, Center for Pacific Basin Studies, with the Federal Reserve Bank of San Francisco. Portions of this paper are adapted from a speech delivered at the Bank of Korea’s 15th Annual Central Banking Seminar, “Increasing Capital Flows Among Countries and Monetary Policy,” in Seoul, Republic of Korea, September 18-21, 2007. Helpful comments were received from Bob Flood, Galina Hale, Ayhan Kose, Andy Rose, and an anonymous referee. Christopher Candelaria provided excellent research assistance.
However, see Ihrig and others (2007), which questions the validity of the global capacity hypothesis based on the domestic consumer price level’s lack of sensitivity to the foreign output gap.
Tytell and Wei (2005) also move beyond a linear specification to allow for “threshold effect” in macroeconomic policies using a transition matrix approach. They find a significantly negative relationship between financial integration and the probability of transitioning from a low to a moderate inflation regime.
As a robustness check, I also follow Rose and Spiegel (forthcoming) and consider financial remoteness as a possible indicator of financial integration itself, with similar results.
Woodford attributes original discovery of this result under unitary elasticity of substitution to Cole and Obstfeld (1991).
Unlike Tytell and Wei (2005), we do not include debt stock data in our openness measure. As discussed in their paper, either measurement method would be biased as coverage of debt volumes is not complete. In any event, our base specification yields results that are similar to theirs, suggesting that the results are insensitive to the inclusion or exclusion of debt flows in the financial openness measure.
The measure is actually the “polity2” score, obtained from the Polity IV Project Data Set. For details, see http://www.cidcm.umd.edu/polity.
As in Rose and Spiegel (forthcoming), the United Kingdom, the United States, and Japan are dropped from the sample. I also drop Luxembourg, which is an outlier in the financial openness measure at over 10,000. The next highest value in the sample, Hong Kong, SAR has a 508 score.
I also examined the implications of including an OECD dummy into the cross-sectional specifications. Unsurprisingly, this variable acted similarly to conditioning for per capita income. Its inclusion knocked out the FinOpeni,t variable when it was introduced on its own. When introduced in the presence of the GDPC01 variable, these two variables tended to cancel each other out, with one entering positively and one negatively, which is not surprising as we would expect them to be quite collinear. These results were submitted to the referee and are available from the author upon request.
Coefficient estimates for fixed effects are suppressed in the tables, but are available upon request from the author.
The polity index is censored at a score of 10, and many of the most industrial countries, such as the G7 countries, earn a score of 10 through our sample. As such, this variable is not time-varying for these countries in panel estimation. As a robustness check, I ran the panel specification without the polity variable and obtained similar results. In particular, the coefficient estimate on FinOpeni,t is close to 0 and very insignificant.
As a robustness check, I added lagged values of inflation, FinOpeni,t, and TrdOpeni,t to the specifications in Table 3. The results were largely robust to the inclusion of these variables. For the OLS specifications, the FinOpeni,t variable of interest remained insignificant, as did its lagged value. For the instrumented specifications, the results were actually somewhat stronger than those reported in the text, in the sense that the coefficient estimate on FinOpeni,t continued to enter negatively at statistically significant levels in Model 4, but was also significantly negative in Model 5. The FinOpeni,t variable again became insignificant after conditioning for GDP per capita. These results were submitted to the referee and are also available from the author on request.