Why Isn’t the Fed Tougher on Banks?

By Kindred Winecoff

I am live at The Washington Post‘s political science blog The Monkey Cage, writing about some of my recent research on the global financial system. One key bit:

[T]his result conforms to a simple logic: if you task central banks with financial stability, they will partially tailor monetary policy to make it so. If banks know that their central bankers have their interests in mind, they will behave with less prudence. It makes perfect sense why this would be the case. So long as banks do not violate their statutory capital requirements there is little that central banks can do to prevent this behavior even if they wished to do so. Economists refer to situations in which actors are able to shift the risk generated by their actions onto others as “moral hazard.” It is one of the greatest economic problems, which can cause entire markets to fail. Isn’t that what’s happening in this situation?

Read the rest here. The underlying research is available on my website here.

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The Persistence of American Financial Power

By Kindred Winecoff

The Financial Times asks whether American financial prominence will endure. These articles recur with far too much frequency, in particular every time there’s a policy impasse. I have an essay (with the excellent Sarah Bauerle Danzman) on that topic in the most recent issue of Symposium explaining why the answer is “yes”. One key bit:

These [conventional] assessments see power as a result of the internal attributes of national economies: large economies with attractive financial sectors have power, while weaker ones do not. Accordingly, the U.S. decline in the share of global trade and income, and its domestic financial instability, should diminish its influence. But this focus fails to consider the ways in which the global financial network is, in fact, a complex and adaptive system. Power within this system does not depend solely on domestic attributes, but on the distribution of financial relationships that exists globally. In other words, the most well-connected economies, not just the biggest, are the most powerful. By extension, change within this structure does not follow a linear process, and economies that are initially more advantaged will continue to grow as the system develops.

The difference between these two approaches is significant. When we conceptualize the international financial system as a network, we see that the U.S. has become more central since 2007, not less. Rather than shift from West-to-East, global financial actors have responded to crisis by reorganizing around American capital to a remarkable extent. This is partially due to proactive responses to the crisis by policymakers such as the Federal Reserve, but it is also the result of factors outside the U.S. Above all, American capital markets remain attractive because complex networks contain strong path dependencies, which reinforce the core position of prominent countries while keeping potential challengers in the periphery. That is to say, policymakers and market players were limited in the decisions they could take because of factors that had already been locked in. As a result, the structure of the global financial system keeps the U.S. at the core and will continue to do so unless the entire network is fragmented, as it was during the 1930s when Great Britain lost its dominance.

Read the whole thing.

For those not familiar, Symposium is an exciting new magazine. It has aspirations to fill part of the void left by the dearly-missed Lingua Franca. It’s an excellent way to publicize research in a way palatable to the public. Working with them was an excellent experience, and I’d strongly recommend folks subscribe as well as considering them as a future outlet for their work.