Jonathan Pincus () (School of Economics, University of Adelaide) Richard Pomfret
Abstract
Financial sector innovation and development has been an integral part of the rise of capitalism over the last half millennium. The innovations of the last three decades of the twentieth century were a continuation of the trend; they contributed to an era of global prosperity, but also increased the probability of bank failures as bankers and policymakers inexperienced in the new instruments made mistaken decisions. The likelihood of crises was increased by public policies which increased moral hazard. Governments regulate the financial sector due to asymmetric information between depositors and deposit-taking institutions; restricting entry or the lending activity of financial institutions is inefficient, so the weight is now placed on deposit insurance with moral hazard consequences. The policy challenge is to reduce moral hazard without repressing the financial sector and creating adverse selection in lending practices. Since the mid-1980s cheap money policies have exacerbated moral hazard associated with inadequate financial sector regulation by encouraging highly leveraged investments. The post-2007 financial crisis was one of many crises with idiosyncratic catalysts but with common underlying causes: cheap money available to participants in the integrated but imperfectly regulated global financial market eventually led to loan defaults and bank failures. This is not the end of capitalism, but a reminder of the difficult balancing acts involved in policing the financial sector which is at the heart of capitalist economies.
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Publisher Info
Paper provided by University of Adelaide, School of Economics in its series Working Papers with number
2009-05.
Find related papers by JEL classification: G01 - Financial Economics - - General - - - Financial Crises O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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[Downloadable!] (restricted)
Romain Rancière & Aaron Tornell & Frank Westermann, 2002.
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854, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2004.
[Downloadable!]