But the political case for free trade depends on whether its distributional, social and environmental consequences can be adequately managed. A similar reasoning applies to the free flow of capital. 22 In principle, free capital flows allow for risk sharing and a better allocation of resources across economies.
They also help economies to catch up in terms of technology and financial market development through the transfer of knowledge. But recent academic analysis and policy experience, both globally and at euro area level, have revealed that capital flows can pose risks. They can be volatile and pro-cyclical, fuelling economic and financial cycles, and eventually asset price bubbles.