Consumption and liquidity constraints in Australia and East Asia: does financial integration matter?

Abstract

One of the recurring themes in the literature on financial systems is whether financial integration – that is, openness in the domestic and international financial system – has real, structural economic effects. This paper examines the effect of financial openness on the consumption of non-durables in Australia and selected East Asian economies. A range of variables, some of which explicitly represent financial regulation, are used to proxy the shadow price of the liquidity constraint. Non-durable consumption in Hong Kong, Japan, Korea, Singapore, Taiwan and Thailand can be modelled as the outcome of constrained optimisation, in some cases with time-varying real interest rates and demographic change, while that in Australia is liquidity unconstrained, at least from the 1980s. The constraint appears constant but very weak in Hong Kong and declining in Singapore, consistent with the extent and timing of domestic and international financial reforms in these economies. It appears unchanged for Japan and Korea. For Taiwan and Thailand, there is strong evidence that domestic financial regulation and control have constrained the intertemporal optimisation of consumption, although the constraint may be expected to unwind with recent liberalisation. The experience of Australia and the selected East Asian economies suggests that the liberalisation of the capital account, combined with deregulation and expansion of the domestic financial sector, eases the constraints on consumption smoothing. Financial integration does matter. The experience of these countries also indicates that there is no simple connection between the openess of a country’s financial system and its saving and investment performance.