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DP8165 Paved with Good Intentions: Global Financial Integration, the Eurozone, and the Imaginary Road to the Fabled Gold Standard


Author(s): Geoffrey R D Underhill

Date of Publication: December 2010

Programme Area(s): FE


Abstract: Regional systems of governance may resolve some of the dilemmas of global financial integration, and the eurozone is among the most advanced examples of attempts to do so. This paper argues that the recent Euroland sovereign debt crisis is a test of this proposition, and the outcome leaves the EU found wanting. The first section of this paper places EMU in the broader context of financial liberalisation and the crisis of 2007-09. The second section demonstrates that there were plenty of warnings in the pre-crisis theoretical and empirical literature in economics and policy studies that financial instability could be closely associated with financial liberalisation, and that robust mechanisms of governance were required to deal with this eventuality. A third section examines the crisis in the Eurozone and the reaction to it in the light of this literature, demonstrating that the lessons available pre-crisis remain poorly learned. The financial market phase of the crisis showed the EU and ECB as capable of leadership and innovation in crisis management. The sovereign debt phase was less successfully managed, with domestic political dynamics stimulating centrifugal tendencies among eurozone members claiming to be committed to an ‘ever closer union’. The reforms so far proposed offer little in terms of optimism. The EU appears to be looking for a functional equivalent of the lost, mythical Gold Standard: if only the rules are the right ones, and everyone behaves properly, stability will be achieved automatically. Such an outcome is unlikely, and the eurozone hangs in the balance as a result of serious policy mistakes.

DP8164 Theory and the Market after the Crisis: the Endogeneity of Financial Governance


Author(s): Geoffrey R D Underhill

Date of Publication: December 2010

Programme Area(s): FE


Abstract: The inheritance of contemporary financial economics invites us to consider financial stability as integral to a liberal market setting. The crisis however demonstrated that financial markets may prove highly dysfunctional in the absence of adequate mechanisms of regulation and governance. This implies that economic theory requires an enhanced understanding of the intersection of economic rationality with the rationality of governance. This article extends the insights of institutional economics to demonstrate that the emergence of the institutions of financial governance is endogenous to the utility-maximising behaviour of competing economic agents. Utility-maximising behaviour and conflict over the terms of competition in the market generate both the formal and informal institutions and processes of governance such as regulation and dispute settlement. The model is illustrated by the case of international finance, predicting forms of policy rent seeking in a market environment: private interests embedded in public policy processes simultaneously reshaped both market and governance in line with their own perceived utility functions. The model predicts that similar policy rent seeking will dominate the reform process. Successful reform will require a conceptual understanding of this link between governance and market competition, and appropriate changes in the nature of the policy process so as to reshape markets to avoid financial instability in the future.

PS: http://pdc.ceu.hu/archive/00001564/01/linear.PDF


December 21, 2010 - Posted by | Uncategorized

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