Financial Crises, Regulation and Growth

By Barrell, Ray; Hurst, Ian et al. | National Institute Economic Review, October 2008 | Go to article overview

Financial Crises, Regulation and Growth


Barrell, Ray, Hurst, Ian, Kirby, Simon, National Institute Economic Review


The paper discusses the effects on growth of a systemic banking crisis as a result of debt defaults. These effects will come from the impact of credit rationing on consumption and credit and from the impacts of a significant rise in the spread between lending and borrowing rates for both producers and consumers. The analysis uses the dynamic stochastic general equilibrium version of the National Institute global model. The paper also investigates the impact on output of a permanent, regulation induced, rise in margins in the financial sector, taking into account the impacts of regulation on equity market valuations.

Keywords: Financial crises: financial market spreads; forward looking consumers; dynamic stochastic general equilibrium models

JEL Classifications: E17; E44

Introduction

A financial crisis has been building since the summer of 2007. It has been driven largely by defaults on US housing loans to consumers and the subsequent collapse of liquidity in interbank funding markets. These have been of a sufficiently large scale as to bring the stability of the banking sector into question. Financial crises are relatively common events, but not often on the scale we are currently witnessing. They often follow periods of financial innovation or deregulation, as borrowers and lenders find themselves in situations where it is hard to evaluate the prices of new types of risk. The globalisation of financial markets has meant that the newly created assets and risks associated with them are shared across banks throughout the world and a number of European banks have suffered major losses as a result of purchasing high-yield high-risk securitised mortgage backed assets originating in the United States.

The paper investigates the impacts of widespread credit rationing and a significant rise in the spread between lending and borrowing rates for both producers and consumers in a rational expectations dynamic general equilibrium version of the widely used NiGEM model.

Credit rationing is a ubiquitous result of financial crises, and it reduces consumption and investment, as Barrell, Davis and Pomerantz (2006) discuss. Quantity rationing of this form may reflect increased asymmetry in information and increased risk aversion on the part of banks. An increase in spreads increases price rationing and can also help banks wishing to rebuild their capital after a crisis. In either case they represent the immediate impacts of a crisis in the banking sector. The paper also investigates the impact on output of a permanent, regulation induced, rise in margins in the financial sector, taking into account the impacts of regulation on equity market valuations.

The current crisis has developed following a wave of complex financial innovations and a period of international financial integration. Innovation and integration should help manage risk, with risk sharing leading to increases in welfare and the reduction in the investment risk premium producing higher output. However, complex innovations seem to have been hiding risk rather than managing it. Financial innovation resulted in lending to increasingly risky borrowers, while the lender could shift risk (the originate and distribute model) completely. Poor quality US loans were bundled and sold on but were difficult to value by conventional means. Because barriers to the movement of financial capital have largely been removed, markets spread risk to other countries where the poor quality of US borrowing and bankruptcy regulation was not fully understood.

Most mortgages in the US are non-recourse loans, as Ellis (2008) discusses. Although they are secured on property, there is no personal liability. Non-recourse loan default does not require that bankruptcy takes place, but even when it does there are still problems for lenders as it remains difficult to recapture the full value of loans. (1) Bankrupts, and those who default on their own homes, are allowed to keep housing equity up to $125,000 or more if they receive below median income. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • A full archive of books and articles related to this one
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Financial Crises, Regulation and Growth
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

    Already a member? Log in now.