The Role of Financial Liberalization in Consumption Booms

Abstract

Consumption booms, defined as unusual upsurge in a country's real private consumption expenditures, are often perceived as dangerous macroeconomic events because of their detrimental effects on home goods prices, the balance of trade, and the resources available for investment. Using a large cross-country panel data set from 1973-2005, this paper assesses how financial liberalization explains the occurrence of consumption booms. There are two key findings: First, while financial liberalization is not responsible for triggering all the consumption booms across the sample, the booms have indeed arisen more readily in the circumstances of financial reform, particularly the liberalization of the capital account, holding other factors constant. Second, the correlation between the probability of booms occurring and financial openness is non-linear. As many emerging economies like India and China are considering fully liberalizing their financial markets, these countries need to be particularly cautious about potential consumption booms that might jeopardize the macroeconomic stability.