The Effect of Financial Market Integration on Monetary Policy and Long-term Interest Rate in Korea and Its Policy Implications

Abstract

Financial market integration mitigates production shocks that occur in a country by pooling the risk through portfolio diversification and this contributes to consumption smoothing for life-time utility maximization. Financial market integration also contributes to economic growth by supplying capital to developing countries via the integrated financial market. However, the integrated financial market also serves as a transition channel where the financial shock which originated from the center country spreads to its neighboring economies. In the event of a financial crisis, there is a potential risk of capital flight from neighboring countries to the financial center, meaning that many countries in the integrated financial market have an economic structure that is vulnerable to external shocks.