This paper explores two policy options in emerging market economies (EMEs) to cope with volatile capital flows due to external monetary policy shocks; capital control policy and choice of exchange rate regime. Both tools reinforce each other when a foreign exchange risk premium shock hits the economy. A contractionary U.S. monetary policy shock has significant real effects in EMEs. Conventional wisdom tells us that a free floating exchange rate with inflation targeting is better when a country faces foreign shocks. However, we show that a flexible exchange rate with less capital controls is not the best option in EMEs based on vector autoregression analysis. Moreover, we set up a small open economy new Keynesian model with real wage and price rigidities. It shows that the small economy with labor market frictions is more vulnerable to exogenous shocks such as a foreign exchange rate shock under a fixed exchange rate regime than under a flexible exchange regime. We show that maintaining price stability is not desirable when there are substantial frictions in the labor market and the intratemporal elasticity of substitution is high. Finally, the model shows that the welfare cost difference between a policy of maintaining purchasing power and a policy aimed at price stability reverses as the intratemporal elasticity of substitution between home and foreign goods increases.

This paper studies the unusual features of emerging economy business cycles in Asia. When we assess whether approaches from the previous literature can explain Asian business cycles, we conclude that standard models based on permanent growth shocks do not replicate key features of Asian business cycles. The evidence suggests that different transmission mechanisms explain the connections between consumption, net exports, and export or import in Latin America and Asia. For evidence of a special transmission mechanism, we study durable goods business cycles in Asia (Korea), noting that strong pro-cyclical durable goods consumption may be explained by the export-income channel coupled with market laddering by which firms have expanded the variety and quality of their durable goods production.

This paper seeks to understand why Asian foreign investment is concentrated in financial markets outside of the region instead of in Asian markets. We analyze empirically the geographical composition of the cross-border portfolio holdings of more than 40 source countries. We compare these benchmark results with those of four subgroups: advanced industrial economies, emerging market economies, European economies, and Asia-Pacific economies. The lack of liquidity in Asian financial markets turns out to be one reason why Asian capital is invested predominantly outside the region, notwithstanding the short distances and large trade flows between Asian economies. Initiatives to improve the liquidity of Asian financial markets, therefore, may be a useful way to stimulate financial integration within the region.

This paper investigates whether financial markets in East Asia are integrated with global markets or with each other.We use two approaches: a volume-based approach and an asset price approach. Our overall results suggest global integration of these markets rather than regional integration and that there is no anchor market in the region that would match the advanced markets such as the United States. Though global integration is not a force that competes with regional integration, there seems to be no strong sign of the creation of an effective financial market mechanism in East Asia.