The Feldstein/Horioka coefficient skirted one for large parts of this period. The global financial system operated as anything but a system. Indeed, it was this which prompted Feldstein and Horioka in the early 1980s to present the “puzzle” of still-low levels of capital market integration. Yet at pretty much precisely the point this puzzle was being identified, it began to disappear. Correlations quickly moved from close to unity in the early 1980s to close to zero by the start of the 21st century. This was an astonishingly rapid evolution from a world close to financial autarky to one close to financial nirvana. In the light of the crisis, measured levels of global capital market integration have fallen somewhat. But they remain at higher levels than at any point in history. Overall, then, the picture is clear. For much of the 20th century, global finance was more patchwork than network. But the past thirty years have seen that picture change spectacularly. Today, global finance is a well-connected network, a tightly-woven and tangled web, a genuine system. The double-edged nature of financial integration So what are the implications of this increase in global financial integration? There have been large numbers of studies exploring the growth and welfare implications of these trends, using cross-country and time-series evidence (Rey (2013)). This evidence paints, at best, a mixed picture. While capital integration ought to enhance international risk-sharing, there is surprisingly little evidence of this having conferred macro-economic benefits – and some of it having imposed costs.
Without them, it would have been impossible to make sense of the chaotic dynamics of global economies and financial systems at the time. In other words, nothing could have provided a better case study of the importance of Max’s work than the crisis. And it is lessons from the global financial crisis with which I want to begin. These are of course many and varied. But among the most important is also perhaps the simplest: to safeguard against systemic risk, the financial system needs to be managed as a system (Haldane (2009)). As put, this statement seems rather obvious, perhaps even tautological. Yet, pre-crisis, it was far from obvious. The orthodoxy then was that safeguarding individual financial firms was a necessary and sufficient condition for system-wide stability. This was the financial stability equivalent of the English aphorism: “look after the pennies and the pounds will look after themselves”. And so it appeared during the long pre-crisis period of stable growth and stable banks – the “Great Moderation” (Bernanke (2004)). The crisis has rewritten that orthodoxy. It revealed that the safety of individual banks was neither a necessary nor sufficient condition for systemic stability. Not necessary because, in any well-functioning system, individual banks can and should fail. Not sufficient because, in an integrated web, the chain is only as strong as its weakest link. In focussing on individual banks, policymakers had been, to coin another English aphorism, “penny-wise but pound-foolish”. That is why Great Moderation gave way to Great Recession (Gai and Kapadia (2010)).