Archive for June 8th, 2009

International Financial Multiplier

June 8, 2009

I came across this very useful paper from Michael Devereux (Univ of British Columbia) and James Yetman (of BIS).

Paul Krugman had developed a model to show how international financial multiplier works. The main idea was how  changes in asset prices are transmitted internationally through their effects on the balance sheets of highly leveraged financial institutions.

In this paper the authors work on the same concept (different model) and show how financial channel works and damages economic prospects:

The recent financial crisis has highlighted the role of interdependence among major economies through linkages among financial institutions, in addition to the trade linkages that are at the centre of traditional models of the international business cycle. This paper develops a model of the international transmission of shocks through de-leveraging across financial institutions. In a macro-economic model in which highly levered investors hold interconnected portfolios across countries, we show that the presence of binding leverage constraints introduces a powerful financial transmission channel which results in a high correlation among macroeconomic aggregates during business cycle downturns, quite independent of the size of international trade linkages.

The authors detail a model which is quite simple to understand. They explain it in English and then use the greeks to make it more rigorous. Minus the Greeks it is pretty readable.

 This paper adds more weight to Krugman’s paper for the multiplier effect and John Geanakoplos for the role of leverage in a financial transaction.  

Good stuff.


The Political Economy of Global Finance

June 8, 2009

I am quite fascinated by the political economy literature. The recent piece by Simon Johnson explaining the growth of finance sector is a must read. The famous pieceby Jagdish Bhagwati explores the rise of US Treasury and Wall Street. Then Stepen Haber looks atpolitical economy of financial development which I thought had reversed.

The list is growing. Ok, now I came across this new paper by Richard Deeg of Temple University and Mary O’Sullivan of University ofPennsylvania. This one is on political economy of global finance.

We center this review article around six important books that represent recent thinking by political economists on global finance and discuss their substance, their implications, as well as some of their shortcomings, for our understanding of the subject. We organize our review around three major questions:

First, who are the players in the political economy of global finance?

Second, what are the causal forces shaping its characteristics? Third, what are the consequences of the current political governance of global finance?

The most important developments that we highlight in this article are 1) the move from a predominant focus on state-centered patterns of regulation to a more comprehensive understanding of the role of states and private actors in building a transnational governance regime that mixes public and private regulation; 2) the intensified effort to understand the causal forces that shape the political economy of global finance based on more complex models that allow for an interaction among interests, institutions and ideas; and 3) increased attention to new sources of systemic risk in the global financial system, as well as a greater consideration of the consequences for domestic politics of interactions with the global financial system.

In the article we argue that the literature must do more to understand the behavior of actors who enact the rules of global finance, not just those who generate the rules. And we argue that more must be done to assess the costs and benefits of financialization at the global and national levels.

Superb stuff.  Consider this point:

Abdelal focuses on the development and proliferation of the rules of capital mobility by three international organizations — the EU, the OECD and the IMF. He takes issue with the conventional wisdom that casts the US as the central state in defining the politics of global finance, arguing that it was really the Europeans, and especially a number of prominent French statesmen, who, since the early 1980s, led the major initiatives at these organizations. In contrast, the US pursued unilateral and bilateral initiatives to facilitate capital mobility while displaying limited interest in generating global rules to govern international finance.

Abdelal’s emphasis on French and European policy makers as “norm entrepreneurs” resonates with Nicolas Jabko’s argument that the primary engine of market integration in Europe was the politically strategic use of ideas by policy entrepreneurs. Jabko gives analytical primacy to the European Commission which, he argues, used alternative conceptions of the enigmatic but powerful idea of the “market” to engineer pro-liberalization coalitions in the EU across a wide variety of market-building initiatives. In his case study of financial market integration in the EU from the early 1990s, Jabko acknowledges that rising global capital mobility and external pressures for reform were important background causes of the liberalization of European financial markets.

Well, well well. This should be a surprise for many (me included).

The paper is full of such developments (how accounting regulations shaped up, credit rating agencies grew etc etc.) The final question is also quite interestingly put:

In reviewing these books, it would have been unfair to read them entirely through the murky light of the ongoing crisis. Nevertheless, we have endeavored to highlight the questions that the crisis raises for the basic issues that these books, and the broader literature, address.

Our discussion also suggests a more general question that the crisis poses for students of the political economy of global finance: how it is that false illusions of the global financial systems operation and consequences were conferred with sufficient legitimacy to deafen alternative views and stymie real reform? It does not take much cynicism to think that answers to this question are likely to be relevant not only for understanding the past, but also the future, of the political economy of global finance.

This crisis might get more people interested in this subject- political economy of development of finance and international finance.

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