Regulatory Cycles: Revisiting the Political Economy of Financial Crises

From a new IMF working paper by Jihad Dagher:

“This paper reviews some of the most infamous financial crisis in history and brings several patterns that are rarely discussed in the literature, at least not in a historical and cross- sectional approach. It shows that in most cases regulation has been pro-cyclical, effectively weakening during the boom and strengthening during the bust. Regulators do not operate in a vacuum, and this paper shows how, in most cases, political interventions have helped fuel the boom in similar ways across time and countries. The political repercussions of crises, partly due to changes in the public’s perception about the role of the government, are usually very significant. They help explain the reversal of policies and the regulatory backlash.

The interplay between politics and financial policy, described in this paper, has not received sufficient attention. The focus of the literature, which has been mostly cast in technical terms, is to find the optimal level of regulation that regulators should be enforc- ing. Will new regulations and their enforcement survive the test of time? History offers a relatively pessimistic answer to this question. It offers plenty of examples where regulatory failures can be attributed to political failures. Strengthened regulations and supervision are, in essence, tools given to regulators to use as long as the political climate allows them to. To what extent can regulators be insulated from changes in politicians’ (and voters’) philosophy toward regulation? What changes need to be made at the institutional level? This is an important question left for future research. Acknowledging the fact that politics can be the undoing of macro-prudential policy would be a step in the right direction.”

Posted by at 2:35 PM

Labels: Macro Demystified


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