INTRODUCTION

In the past, foreign shocks to emerging economies (EMEs) spread out mainly through the trade channel, and transmissions to local economies took time to come into effect. This could certainly be considered a by-product of the international financial setting designed at the Bretton Woods Conference, where capital flows remained mostly local. As sovereign states benefited from more policy room, they were less constrained when fixing monetary and fiscal policies. The availability of policy options did not shield them, however, from macroeconomic instability and recurrent gaps on both the external and the fiscal front, and particularly affecting (by the time categorized as) developing Latin American and Asian economies. Yet this relatively harmonious world was predestined to alter, as cross-border flows began to erupt in the late 1960s, pushing local financial markets towards unchartered waters. Thus, we can trace the origins of the 2008 global turmoil to the collapse of the Bretton Woods system in the early 1970s, when leading developed nations agreed to a progressive dismantling of the former controls on capital flows and when the banks' transnationalization journey began. Overflowing with liquidity, thanks to large, readily available deposits (Eurodollars) and strongly rising petroleum prices (petrodollars), US (basically) transnational banks set out to find new clients everywhere – including those living in distant and less developed countries. A new era for global banks began. Small (and now open) economies were suddenly at the mercy of the constraints imposed by the so-called monetary trilemma.

The shift towards free markets was accelerated after Margaret Thatcher in the United Kingdom and Ronald Reagan in the United States came to power in 1979 and 1980 respectively. The dominant (neo-liberal) view perceived increased financial activity as beneficial for development, and Keynesian–Myskian caveats were suddenly set aside by policymakers and disregarded by mainstream economists around the world. By the same token, the efficient market hypothesis gained space and substituted Keynes's beauty contest parabola in trying to explain how financial markets actually behave. That was the central message that emanated from international financial institutions (IFIs) through the instructions and the recommendations laid out by the Washington Consensus. From then on, developing countries were urged to liberalize their capital account and deregulate their financial sector.

Capital returned to the developing world in the early 1990s, but now under a new format: bonds were replacing (syndicated) bank loans, a popular financial scheme during the 1970s. Capital inflows were not free of cyclical downturns and sudden stops, however, the consequences of which were observed elsewhere. In some cases, the crisis responded to internal factors as macroeconomic imbalances originated at public or private dislocations that made unsustainable the peg being adopted. In most cases, however, the crisis followed external factors.

Irrespective of the country fundamentals, officials at the International Monetary Fund (IMF) replicated the same (orthodox) recommendation: sustain the macroeconomic adjustment and announce important structural changes. Among the changes requested by IMF staff, maintaining the capital account liberalization process remained key for those expecting its financial help – although the Fund was now willing to debate whether sequencing should overtake shock therapy. Furthermore, and even after the collapse in Asia, the leading nations of the IMF, headed by the United States, attempted to amend the Articles of Agreement to extend the Fund's jurisdiction to capital movements, associating them to members' current obligations under the current account chapter.

Thereafter, the crisis would affect the Fund as few emerging market economies (EMEs) remained interested in being part of its loan programmes – 'Not Even a Cat to Rescue' ran a headline in The Economist} In any case, conscious of the constraints that were imposed in the past and their failures, EMEs' leaders began to abandon the neo-liberal template offered by Washington, DC. Governments in emerging markets and developing countries decided to better accumulate foreign reserves in an attempt 'to immunize themselves' against a hypothetical sudden stop. Other countries went even further and reintroduced capital controls. In one way or another, all of them were clearly trying to enhance their financial resilience and to expand their policy space. All these changes were signalling the beginning of a new era, although few were aware of it.

In the North, few were ready to acknowledge either the procyclicality of the financial system or the destructive power of financial innovations (sometime later described as 'weapons of mass destruction' by Warren ('Buffett Warns on Investment "Time Bomb" ', BBC News, 4 March 2003)). They were just enjoying life under the 'great moderation' years (Ben Bernanke, 'The Great Moderation', 20 February 2004, federalreserve.gov). Monetary policy was primarily centred on price stability, and it disregarded the mounting credit balloon and asset price booms being generated by market liquidity. Mainstream economists, in contrast, were hardly attracted to the idea of integrating financial factors into their models.

Despite this business as usual picture on mainstream minds, a new financial boom mounted, which was now associated with the arrival of new funding sources (non-core financing), including derivatives and other non-lraditional products. Independently of the original sources, global liquidity would be transmitted to EMEs through transnational banks. The arrival of this non-core banking funding (foreign creditors) permitted local banks to support the entry of new borrowers at home – formerly exclusively backed by domestic savers. But a financial system based on cross-border banking tends to raise risks at home as external liabilities (wholesale funding) prove more volatile than normal retail funding (domestic depositors). Additionally, in most cases financial flows remained weakly regulated as monetary authorities pursued banks' self-regulation and financial micro-prudential measures.

External pressures were not eliminated after the 2008 global financial crisis, however. Initially economic authorities accurately responded to the challenge, but unconventional monetary policies in the United States and other developed countries...