Government's Role in an Interconnected Global Financial Market Essay

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Recent events have merely confirmed what economists have known for some time, namely, that the interconnectedness of global economic activity renders macro-management by single governments redundant. Their function is now to regulate markets to ensure economically efficient solutions.

This essay will argue that the 2008 financial crisis has brought to the forefront of global political consideration what some economists have known for some time. This is that 1) The global financial system is inherently flawed and cyclical recessions are a product of its nature 2) The interconnectedness of the global financial system means macro-management cannot fully buffer an economy against these cyclical recessions 3) Policy has …show more content…
The evidence assessed in this study would certainly suggest a countries participation in global financial markets 1) increases economic cycle volatility 2) reduces policy effectiveness and 3) reduces the influence and power of the government.
The effect of foreign capital on policy effectiveness as Kumar observed, can be significant. Alfaro (2010) shown that as of 2007, FDI represented 17.2% of capital formation in developed nations. Looking at OECD data for a developed nation such as Britain, we can see that in the 3 years prior to the crisis (2005-07), it attracted £95 billion in 2005, £75 billion in 2006 and £81 billion in 2007 through foreign direct investment from just the OECD nations alone. Any monetary policy hoping to slow down transactions within such an environment would have to contest with such huge capital influx having, as large government spending would, knock-on effects reverberating throughout the economy. Considering FDI, trade and production inflows and speculative capital movement, there is an enormous amount of capital swilling round economies providing exogenous factors that reduce policy effectiveness and governments do not have the policy instruments available to effectively
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