The transmission mechanism of financial crisis to developing countries: why the 'global financial crisis' wasn't global

Despite a large literature on the destabilising effects of capital account liberalisation, there is little analysis of how financial crisis is transmitted from financially advanced countries to developing countries. This is in large part because the usual direction of transmission is from the developing countries or emerging markets to the more advanced countries in which global financial centres are based. This chapter identifies three channels through which financial crisis has been transmitted to developing countries and emerging markets. These are a financial channel through illiquidity in the international monetary system, and hence in government and corporate balance sheets, causing debt crises; a monetary channel, when exchange rates change the value of external liabilities; and thirdly an export channel, if the value of exports falls below the value required to maintain production and service external debt. The chapter argues that because of developments in these three channels, unconventional measures of monetary policy ensured that the 2008 financial crisis had only minimal effects in developing countries and emerging markets. Capital controls are not an effective solution and the problem of managing capital flows to developing countries remains a challenge for international monetary policy.