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The rapid spread of Covid-19 has predictably stirred fears around greater globalization and created ripple effects on financial markets globally, complicating the task of central bankers and policymakers across the world.

Such risks are par for the course in a globalized world, making it tougher for central banks to maintain financial stability, wrote economists Simone Arrigoni, Roland Beck, Michele Ca’ Zorzi, and Livio Stracca in VoxEu, a research portal run by the Centre of Economic Policy Research (CEPR).

The researchers argue that in an open economy, policymakers can simultaneously achieve only two of three key objectives: financial stability, independent national financial policies, and cross-border financial integration.

This “financial trilemma" means that unless policymakers are prepared to tame globalization, preserving financial stability would require compromising the independence of monetary policy.

The researchers find that both real economy indicators, such as output and physical investments, and financial indicators, such as bank credit and stock prices, tend to move together across countries.

This “co-movement" is much stronger in reality than suggested by economic theory. Given the growing financial linkages in a globalized world, this means that the real sector of different countries are much more intertwined than ever before.

The researchers show that in the high globalization period (post-2003) such cross-country linkages were higher for most economic variables compared to the period of relatively low globalization (pre-2003). Better use of macro-prudential policy tools, such as limits on debt exposure and flexible reserve requirements, can help policymakers combat global headwinds better, the researchers write.

Also read: Globalisation: What’s at stake for central banks (bit.ly/2Q7yAZQ)

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