It is hardly surprising that economists who are interested in analysing international financial integration focus primarily on the relationship between interest rates on internationally traded financial instruments such as money market instruments and government and corporate bonds. This is, after all, a major part of international financial integration. But it is not the whole story. The macroeconomic impact of international financial integration also depends on the extent of domestic financial integration – that is, the integration of domestic institutional interest rates such as deposit and loan interest rates with domestic money market rates – which itself turns on the regulatory and competitive structure of domestic financial markets. This is particularly important in assessing the international financial integration of east Asian economies, since domestic financial markets in these countries are in very different states of development. This chapter focuses on the changing relationship between the money market interest rate and deposit and lending interest rates in the economies of Australia, Hong Kong, Indonesia, Korea, Japan, Malaysia, the Philippines, Singapore, Taiwan and Thailand. The analysis centres on the integration of retail with wholesale markets – or, alternatively stated, with the relationship of non-traded with traded financial instruments.

The first section motivates the analysis of domestic integration by examining the relative depth of money markets and institutional markets in each country.