Endnotes

¹Bulgaria, Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, the Slovak Republic, and Slovenia.

²The CEE countries are Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic, and Slovenia. We do not include Cyprus and Malta in this paper because their underlying economic characteristics are different from the transition economies.

³Throughout this paper the terms “international financial integration”, “capital account liberalization” and “financial openness” are used interchangeably.

⁴Arvay (2005) discusses in details the capital account liberalization in eight of the new EU member states (Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Republic, and Slovenia).

⁵Article VIII.

⁶The relevant provisions are under Articles 56 EC to 60 EC.

⁷Some of these provisions are prudential measures and their aim is not necessarily to control capital flows.

⁸Stock-based measures are less affected by short-term economic fluctuations (see IMF, 2007; Kose, et. al, 2006).

⁹Unweighted cross-country averages.

¹⁰The Euro area includes Austria, Belgium, Finland, France, Germany, Greece, Italy, the Netherlands, Portugal, and Spain. Ireland and Luxembourg are not included as they are extreme outliers due to their positions as major offshore centers.

¹¹People's Republic of China, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand, and Viet Nam.

¹²For surveys of the recent literature, see for example Kose et al. (2006), IMF (2007a).

¹³For a discussion of the composition of capital flows to CEE countries, see also (Arvai, 2005) and Lane and Milesi-Ferretti (2007).

¹⁴See Lane and Milesi-Ferreti (2007).

¹⁵Von Hagen and Traistaru-Siedschlag (2006) discuss in detail the extent and causes of real currency appreciation in the new EU member states.

¹⁶As pointed out by Buiter and Grafe (2002), even foreign direct investment can be quickly reversed if there are well developed markets for equity and corporate securities.

¹⁷Note, however, that even foreign direct investment inflows could be reversed quickly, if foreign investors could sell their assets in liquid domestic securities or equities markets. (Buiter and Grafe, 2003).

¹⁸Let yi = Ai (ki)á be output per employed worker in country i, with ki the capital labor ratio, Ai total factor productivity, and á = 1/3 the capital elasticity. The marginal product of capital is MPCi= áAi(ki)-(1-á). The capital labor ratios are computed using output in PPP dollars from the World Economic Outlook 2004 database and labor force and unemployment data from the World Bank's World Development Indicators.

¹⁹IMF (2003) presents empirical evidence that institutional quality affects economic growth. Studying growth patterns in transition economies, Grogan and Moers (2001) find that institutional improvements lead to higher growth and stronger foreign direct investment. Alfaro et al (2003) find that, in a sample of 50 countries, institutional weakness is an important hindrance against capital inflows to poor countries.

²⁰Lipschitz does not give estimates for Cyprus and Malta.

²¹Jonas (2004) notes that global capital flows to emerging market economies surged in 2003, but predicts that they will be reduced in the coming years.

²²A recent paper by Detken and Gaspar (2004) shows that fear of floating could also stem from the combination of inflation targeting and a specific monetary-policy rule in a neo-Keynesian model.

²³The Exchange Rate Mechanism (ERM-2) is the official framework of the ECB within which EU countries can choose to peg their currencies to the euro. It stipulates a central parity which can be adjusted by agreement between the ECB and the respective country, and bands of +/- 2.25 percent. Importantly, it does not stipulate a requirement for the ECB to intervene in support of a participating currency. Countries that wish to join the Euro area are required to participate in the ERM-2 for at least two years without devaluing their currencies on their own initiative.

²⁴See Begg et al. (2003) and the literature discussed there.

²⁵Kopits (2000) also notes the usefulness of credible medium-term fiscal plans (rules in his terminology) to avert currency crises in emerging-market economies.

²⁶For banking crises, see Borio et al. (2004) and Ho and von Hagen (2007). For currency crises, see Kaminsky and Reinhardt (1999).

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