Financial Globalization, Crises, and Contagion

Different forces and potential benefits are pushing towards increasing financial globalization. However, globalization can carry important risks. This paper reviews the literature on crises and contagion in the context of financial globalization. Countries with weak fundamentals become more prone to crises when they liberalize their financial sectors. Globalization can also lead to crises in countries with sound fundamentals, due to imperfections in financial markets or external factors. Moreover, open economies are exposed to contagion via different channels such as real links, financial links, and herding behavior. Still, in the long run, the net effects of financial globalization are likely to be positive. The main challenge for policymakers is thus to manage the process as to take advantage of the opportunities, while minimizing the risks.