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How financial innovation might cancel out bank regulation along financial cycles. A Keynes's state of confidence interpretation

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  • Konstantinos Loizos

Abstract

The question posed in this paper is how financial innovation may render conventional bank regulation ineffective. It is argued that the root cause as well as the essence of financial innovation is the predominance of trust in the financial markets, as it is confidence in the financial markets which makes the acceptance of financial innovation possible. In particular, mutual trust in the interbank market depends on the degree of confidence by which expectations are held, which, in turn, affects the relevant risk premia. Consequently, bank regulation may fail to accomplish its stabilization purpose if it cannot check overconfidence in the upswing or inspire and redress lack of confidence in the downturn.

Suggested Citation

  • Konstantinos Loizos, 2014. "How financial innovation might cancel out bank regulation along financial cycles. A Keynes's state of confidence interpretation," Working Papers PKWP1403, Post Keynesian Economics Study Group (PKSG).
  • Handle: RePEc:pke:wpaper:pkwp1403
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    File URL: http://www.postkeynesian.net/downloads/working-papers/PKWP1403.pdf
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    References listed on IDEAS

    as
    1. Éric Tymoigne, 2011. "Measuring Macroprudential Risk: Financial Fragility Indexes," Economics Working Paper Archive wp_654, Levy Economics Institute.
    2. Heid, Frank, 2007. "The cyclical effects of the Basel II capital requirements," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3885-3900, December.
    3. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, January.
    4. Nigel Jenkinson & Adrian Penalver & Nicholas Vause, 2008. "Financial Innovation: What Have We Learnt?," RBA Annual Conference Volume,in: Paul Bloxham & Christopher Kent (ed.), Lessons from the Financial Turmoil of 2007 and 2008 Reserve Bank of Australia.
    5. David Dequech, 2005. "Confidence and alternative Keynesian methods of asset choice," Review of Political Economy, Taylor & Francis Journals, vol. 17(4), pages 533-547.
    6. James Crotty, 2009. "Structural causes of the global financial crisis: a critical assessment of the 'new financial architecture'," Cambridge Journal of Economics, Oxford University Press, vol. 33(4), pages 563-580, July.
    7. J. M. Keynes, 1937. "The General Theory of Employment," The Quarterly Journal of Economics, Oxford University Press, vol. 51(2), pages 209-223.
    8. L. Randall Wray, 2009. "The rise and fall of money manager capitalism: a Minskian approach," Cambridge Journal of Economics, Oxford University Press, vol. 33(4), pages 807-828, July.
    9. Charles W. Calomiris, 2009. "Financial Innovation, Regulation, and Reform," Cato Journal, Cato Journal, Cato Institute, vol. 29(1), pages 65-91, Winter.
    10. David Dequech, 1999. "Expectations and Confidence under Uncertainty," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 21(3), pages 415-430, March.
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    More about this item

    Keywords

    Financial innovation; bank regulation; state of confidence; financial cycles;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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