Fragile Financial Markets

Abstract

In fact, in the economic literature, a remarkable consensus exists concerning the importance of financial market development in reducing adverse effects of economic and monetary shocks related to exchange rate changes in the presence of net balance sheet effects (cf. Levy-Yeyati, 2006; Aghion et al., 2009). The literature unambiguously highlights the importance of well-developed financial markets, in particular the development of local currency-denominated financial instruments, as highly relevant to mitigate the aforementioned adverse effects on net wealth and monetary policy constraints.

[T]he development and active use of a fixed-rate local currency market for funding government and corporate financing needs is probably the single most important step an LDC [less developed country] can take in reducing its sensitivity to external shocks. (Pettis, 2001: 168)