Financial crises have consistently followed periods of “pro-cyclical regulatory policies” by governments over the last 300 years that fostered financial booms and risk taking, according to a paper published by the International Monetary Fund (IMF) Jan. 15.
“Post-crisis regulations do not always survive” the following economic boom, wrote Jihad Dagher, an economist in the macro-financial division of the IMF Research Department, in his paper “Regulatory Cycles: Revisiting the Political Economy of Financial Crises.”
The “IMF Working Paper” looks at the political economy of financial policy during 10 of the “most infamous” financial booms and busts since the 18th century, according to the paper’s abstract, and “presents consistent evidence of pro-cyclical regulatory policies by governments.” Among the 10 crises reviewed in the 90-page paper: the 2007-08 Great Recession in the U.S.
“Financial booms, and risk-taking during these episodes, were often amplified by political regulatory stimuli, credit subsidies, and an increasing light-touch approach to financial supervision,” Dagher wrote. “The interplay between politics and financial policy over these cycles deserves further attention. History suggests that politics can be the undoing of macro-prudential regulations.”
The author wrote that “regulators do not operate in a vacuum, and this paper shows how, in most cases, political interventions have helped fuel the (economic) boom in similar ways across time and countries.” He wrote that the political repercussions of crises, partly due to changes in the public’s perception about the role of the government, are usually very significant. “They help explain the reversal of policies and the regulatory backlash.”
The author notes that history offers many examples where regulatory failures can be attributed to political failures. “Strengthened regulations and supervision are, in essence, tools given to regulators to use as long as the political climate allows them to,” Dagher stated. “To what extent can regulators be insulated from changes in politicians’ (and voters’) philosophy toward regulation? What changes need to be made at the institutional level? This is an important question left for future research. Acknowledging the fact that politics can be the undoing of macro-prudential policy would be a step in the right direction,” the author stated.