Regulatory Cycles: Revisiting the Political Economy of Financial crises

Regulatory Cycles: Revisiting the Political Economy of Financial crises

Financial crises are traditionally analyzed as purely economic phenomena. The political economy of financial booms and busts remains both under-emphasized and limited to isolated episodes. The policy discussions and economic literature generated by the most recent wave of financial crises have been usually cast in technical terms and tended to overlook political forces that shape regulations over time. The narrative tends to revolve around the view that financial innovations are much ahead of regulators. This paper examines the political economy of financial policy during some of the most infamous financial booms and busts since the 18th century, and presents consistent evidence of pro-cyclical regulatory policies by governments. Financial booms, and risk-taking during these episodes, were often amplified, if not ignited, by political regulatory stimuli, credit subsidies, and an increasing light-touch approach to financial supervision. The regulatory backlash that ensues from financial crises can only be understood in the context of the deep political ramifications of these crises. In cases where the regulatory response weakened over time, this usually happened mostly during the course of the following boom. The interplay between politics and financial policy over these cycles, and their institutional underpinnings, deserve further attention. History suggests that politics can be the undoing of macro-prudential regulations.

Jihad C. Dagher

International Monetary Fund, Research Department

November 27. 2017

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