Financial and macroeconomic instability in the emerging market economies

The enormous increase in liquid assets that has taken place with financial globalization is beneficial to global financial market participants. When capital flows take place easily and smoothly into and out of emerging market economies, these economies benefit from more investment as well as an increased ability to diversify risk. The flip side of this coin is that the enormous increase in liquid assets and global inflows and outflows of capital can be worrisome for several reasons: it erodes central banks’ ability to exercise monetary control; it tends to appreciate currency and triggers inflationary pressures; it may facilitate the opening of speculative positions; and it may cause the quality of credit in the system to decline. This could create serious instability in financial markets as well as in real markets.