We Are Not Macroprudentialists: A Skeptical View of Prudential Regulation to Deal with Systemic Externalities

By Glavan, Bogdan; Anghel, Flavia | Independent Review, Winter 2013 | Go to article overview

We Are Not Macroprudentialists: A Skeptical View of Prudential Regulation to Deal with Systemic Externalities


Glavan, Bogdan, Anghel, Flavia, Independent Review


The aftermath of the 2008 global financial crisis has brought a revision of economic ideas, in particular a new wave of skepticism concerning financial markets' ability to function smoothly. (1) At the core of this skepticism is the idea that because of systemic externalities, a free market is exposed to episodes of boom and bust. As this market-failure argument goes, only by chance are the social benefits and costs of financing and investment decisions equal. Rational investors and financial institutions typically value risk and liquidity risk from their own "private" perspective, ignoring the larger social benefits of liquidity and the aggregate dimension of risk. As one advocate of this perspective aptly puts it,

The current financial crisis is a clear example of systemic failure. It illustrates-once again--the vulnerability of market capitalism to spectacular boom and bust cycles that can devastate the real economy. After decades of complacency about the ability of markets to correct themselves and the resiliency of the economy to financial and other shocks, we have experienced another spectacle of irrational herd behavior producing rapid increases in asset values, lax lending standards and over-borrowing, excessive risk taking, and out-sized profits in the financial sector. The boom was followed by a dramatic crash that spread rapidly through world financial markets, causing plummeting asset values, rapid deleveraging, risk aversion, and huge losses. (Rivlin 2009, 2)

Immediately after the onset of the crisis, a widespread consensus emerged among policymakers and academics that a new "macro" approach to prudential regulation, aimed at containing these externalities, is needed to stabilize the economy in the future. The dictum "We are all (to some extent) macroprudentialists now," coined by Claudio Borio (2003, 1), has gained momentum and justification in an avalanche of professional publications and public speeches.

In this article, we discuss the argument for prudential regulation from a skeptical perspective for two reasons. First, whereas readers can easily browse through a substantial body of literature justifying increased regulation, consistent critical works are considerably more difficult to find. We attempt to fill this gap and provide an opposing view. Second, troubled times give an inherent weight to state interventions and interventionist theories, as society asks or waits for the government to "do something." Therefore, we believe that in the current economic, social, and political context it is too easy for interventionist arguments to overshoot in the realm of decision making.

Our central claim is to show that the case for prudential regulation, notwithstanding its new theoretical rationale, is no better at present than it was before the crisis. We critically examine the idea that borrowing creates systemic externalities that give rise to herd behavior, catching the economy in a trap of multiple equilibria from which it can escape only with the help of a countercyclical prudential policy.

Systemic externalities, Systemic Risk, and Coordination Failures

The concept of systemic externallty purports to provide a solid ground for some sort of economic dirigisme. (2) Systemic externalities express the idea that individual behavior often entails a chain reaction or amplification effects that impact, positively or negatively, the whole market. Because of this phenomenon, the economy spirals up or down as investors' buying or selling stimulates third parties to imitate their behavior.

This idea's history can be traced back to the writings of authors such as Paul Rosenstein-Rodan (1943) and Ragnar Nurkse (1953), who explained underdevelopment as the natural result of a "vicious" network of interdependencies among economic agents and phenomena. After having fallen into oblivion for a while, the idea became fashionable again in the 1980s, when economists such as Douglas Diamond and Philip Dybvig (1983) and Kevin Murphy, Andrew Shleifer, and Robert Vishny (1989) began to use rational expectations models to elaborate multiple-equilibria theories in regard to bank runs, investment, and economic growth. …

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

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
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

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

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

We Are Not Macroprudentialists: A Skeptical View of Prudential Regulation to Deal with Systemic Externalities
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
Items saved from this article
  • Highlights & Notes
  • Citations
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.”

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.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, 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." (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.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.