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After the crisis: demystifying financial regulation and debt-inflation-growth Anis Chowdhury Department of Economic and Social Affairs (UN-DESA) Professor of Economics, University of Western Sydney, Australia IDEAs Conference on Reforming Financial System Growth Commission (Dec. 2009)
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Department of Economic and Social Affairs (UN-DESA)
Professor of Economics, University of Western Sydney, Australia
IDEAs Conference on Reforming Financial System
“The crisis delegitimized an influential school of thought, which held that many financial markets could be left to their own devices, because the self interest of participants would limit the risks they took.” (p. 3)
TWO distinct categories according to motives:
Outcomes: contrary to the prediction or rationale -
Dismantling or lack of strong prudential regulation is identified as the root cause.
Therefore, discussion of regulatory reforms focuses mostly on prudential or macro-prudential ones.
However, a laissez-faire approach to “economic regulation” and the deregulation of interest rates can also be contributory factor.
That is, excessive bidding for deposits leads to higher interest rates. Thus, banks must charge higher rates for loans which attract risky borrowers.
Excessive interest on deposits as a threat to both the liquidity and solvency of banks.
Especially when there were too many banks competing for deposits, squeezing profit margin.
Evidence of the deterioration of FIs’ asset portfolios was already emerging in 1996
Opening up banking systems to new entrants lowered the franchise value (expectation of future profits) of existing banks.
Share of Rural Sector in Total Bank Deposits & Advances (%)
e.g. global credit controls that stem from macroeconomic objectives also fulfil a prudential function to the extent that they restrain banks from imprudent expansion of credit.
“Good”, “Responsible” and “Sound” finance are buzz words
Fear of debt & inflation leading to calls for mopping up the stimulus packages
This is not new:
President Roosevelt quickly backed down and promised “a balanced budget [was] on the way”. In 1938, slashed spending for fear of inflation, although unemployment shot up to 19%.
For developing country context – Rao (1952); Dasgupta (1954)
Most developing countries have to depend on debt financing: i.e. printing money for addressing both recovery and development needs
But the effectiveness is doubted even as early as in the 1950s
V.K.R.V. Rao (1952); A.Dasgupta (1954) used different logics, but arrived at the same conclusion – inflationary with no impact on growth and employment.
See, Lerner (1943)