RDP 9602: Consumption and Liquidity Constraints in Australia and East Asia: Does Financial Integration Matter? 6. Conclusion

The literature on the effects of financial liberalisation on the macro-economy is mixed (Fry 1995). This paper has presented strong evidence that financial integration affects the ability of households to smooth their consumption over time. Non-durable consumption in Hong Kong, Japan, Korea, Singapore, Taiwan and Thailand can be modelled as the outcome of liquidity-constrained optimisation, while that in Australia is liquidity unconstrained from at least the 1980s. The constraint is very weak in Hong Kong and is declining in Singapore, consistent with the extent and timing of domestic and international financial reforms in these economies. The constraint appears unchanged in Japan and Korea. For Taiwan and Thailand, there is strong evidence that domestic financial regulation and control have constrained intertemporal optimisation of consumption. There has been major financial reform in these economies, but it is only recent (and piecemeal in the case of Taiwan), and since the tests are conducted on annual data, the effect of unwinding the constraint will take time to appear. The experience of the countries analysed in this paper suggests that liberalisation of the capital account, combined with deregulation and expansion of the domestic financial sector, is necessary for constraints on consumption smoothing to be eased. Financial integration does have real effects, in this case on the time profile of consumption. The experience of these countries also indicates that there is no simple connection between the openness of a country's financial system and its saving and investment performance.