Stability of the Global Financial System: Regulation and Policy Response



Background:
The world has experienced a series of financial crises in recent years, each unfolding in one emerging market country with knock-on effects elsewhere around the globe. Beginning with Mexico in late 1994, crisis-stricken countries have included Thailand, Korea, Indonesia, Russia, Brazil, Turkey and most recently, Argentina. In each case, the crisis had roots in macroeconomic policies (fiscal, monetary, and exchange rate policies) and microeconomic policies (supervision and regulation of financial markets, and industrial policy). These policies formed the backdrop of the crisis, and policymakers struggled to find the appropriate response that would restore economic order, limit contagion effects, and shore-up confidence in financial markets. Not enough has been learned about the dynamics of and appropriate responses to such crises, and critical questions remain:

What are the precise mechanisms that make systemic financial crises so devastating?

What principles should crisis management policy follow? In particular, how should monetary policy be conducted?

How can regulation be better designed so as to balance stability and efficiency of financial markets?

How can the institutions governing the global financial system be reformed to promote well-functioning capital markets?

Systemic crises feed on the endogenous amplification of financial distress through collateral constraints, declines in market values of assets, currency mismatches on the balance sheet, and limited liquidity. The precise channels of propagation of the crisis determine the appropriate policy response ex post, and also the appropriate preventative regulatory measures ex ante. This project proposes a programme of concentrated research that will shed light the causes and dynamics of crises, and hence on the correct policies, both ex ante and ex post. There are implications for the debate on the reform of the institutions of the global financial system.

Journals, seminar papers and other publications:
Dungey, M., Goodhart, C. and D. Tambakis (2005), “The US Treasury market in August 1998: Untangling the effects of Hong Kong and Russia with high frequency data”, CERF Working Paper 24, available at , submitted to International Finance, Jan. 2006.

Cornand C with Heinemann F. (2007), “Optimal Degree of Public Information Dissemination”, The Economic Journal, forthcoming.

Cornand C. with Baeriswyl R. (2006), “Monetary Policy and its Informative Value”, Financial Markets Group Discussion Paper, No. 569, July (to be presented at the Conference “Monetary Policy, Transparency, and Credibility” at the Federal Reserve of San Francisco in March 2007).

Cornand C. with Baeriswyl R. (2006), “Can Opacity of a Credible Central Bank Explain Excessive Inflation?”, mimeo, May.

Cornand C, Heinemann F. (2006), “Speculative Attacks with Multiple Sources of Public Information”, Financial Markets Group Discussion Paper, No. 570, June.

Cornand C with Heinemann F. (2007), “Optimal Degree of Public Information Dissemination”, The Economic Journal, forthcoming.

Cornand C. with Baeriswyl R. (2006), “Monetary Policy and its Informative Value”, Financial Markets Group Discussion Paper, No. 569, July (to be presented at the Conference “Monetary Policy, Transparency, and Credibility” at the Federal Reserve of San Francisco in March 2007).

Cornand C. with Baeriswyl R. (2006), “Can Opacity of a Credible Central Bank Explain Excessive Inflation?”, mimeo, May.

Cornand C, Heinemann F. (2006), “Speculative Attacks with Multiple Sources of Public Information”, Financial Markets Group Discussion Paper, No. 570, June.

Goodhart, C. A. E. with Schoenmaker, D. (2006) “Burden sharing in a banking crisis in Europe”, Swedish Riksbank Economic Review, No. 2006/2, pp. 34-57.

Goodhart, C. A. E. with Surinand, P. and Tsomocos, D. (2006), “A model to analyse financial fragility”, Economic Theory, 27, pp. 107-142.

Goodhart, C. A. E. with Tsomocos, D. and Zicchino, L. (2007), “Financial stability: theory and applications”, Annals of Finance, 3(1), pp. 1-4.

Goodhart, C. A. E. with Aspachs, O., Tsomocos, D. and Zicchino, L. (2007), “Towards a measure of financial fragility”, Annals of Finance, 3(1), pp. 37-74.

Goodhart, C. A. E. (2006), “Searching for a Metric for Financial Stability”, JMCB-FDIC 2006 conference invited lecture

Goodhart, C. A. E. (2007), “Is Forbearance always Bad? How can we test whether its use lessened the incidence of crises?”, forthcoming Central Banking.
Steiner, J. (2006), “Coordination Cycles”

Goodhart, C. A. E. with Aspachs, O., Segoviano, M. Tsomocos, D. and Zicchino, L. (2007), “Searching for a metric for financial stability”, FMG Special Paper No. 167.

Huhnerbein, O. (2007), “Coordination, Aggregation and Seniority in the Pricing of Sovereign Debt”.

Minguez Afonso, G and Shin, H. S. (2006), “Liquidity and flows in the payment system”.

Perez, A. (2007), “Endogenous Market Incompleteness, Idiosyncratic Production Risk and the Business Cycle”.

Schmidt, N. (2007), “Foreign bank entry and credit market segmentation”.

Shin, H. S. “Risk and Liquidity in a System Context” (presented at the Federal Reserve Bank of New York conference on systemic risk, May 17-18, 2006)

Shin, H. S. with Plantin, G. “Carry Trades and Speculative Dynamics” (presented at the Federal Reserve Bank of Atlanta conference on financial stability, April 17-18th, 2006)

Shin, H. S. with Adrian, T. “Money, Liquidity and Financial Cycles” (paper was presented at the 4th ECB Central Banking Conference, Frankfurt 8-9 November 2006)

Dungey, M., Goodhart, C. and D. Tambakis (2005), "The US Treasury market in August 1998: Untangling the effects of Hong Kong and Russia with high frequency data", CERF Working Paper 24, available at http://www.cerf.cam.ac.uk


Researchers:
Professor Hyun Shin
Professor C A E Goodhart
Dr J Danielson
Dr A Dasgupta
Dr Z P Zigrand
London School of Economics

Contact:
Professor Hyun Shin
Financial Markets Group Research Centre
London School of Economics
Houghton Street
London
WC2A 2AE

Tel: 020 7955 7891
email: h.s.shin@lse.ac.uk

Duration of Research:
April 2005 - March 2008