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Emerald Group Publishing Limited
Copyright © 2010, Emerald Group Publishing Limited
Understanding the sources of economic and financial instability
Article Type: Editorial From: Journal of Financial Economic Policy, Volume 2, Issue 2
Not surprisingly, the global financial crisis is still making headlines. Things seem to be getting better for a time but then there are reports that a new country is experiencing severe financial difficulties. In early June, it was Hungary that rattled the markets with reports that it might default on its debts. Regardless of these types of disruptive events, it is clear that there will be a continuing need for ongoing research to more fully understand the underlying factors that caused the most recent crisis and the extent to which factors differed across countries. It is only through such research that meaningful financial reforms to prevent future crises in individual countries can be identified.
What this means is that there are substantial opportunities for researchers everywhere to pursue research that can contribute to helping shape policy decisions that contribute to not only greater financial stability but more generally to improving social welfare in countries around the world.
Our editorial policy is to publish research that covers a broad range of topics that can help promote better financial and economic policies in countries around the world, whether such policies are formulated and implemented at either the government or corporate level. The journal, therefore, welcomes receiving papers that will meaningfully contribute to accomplishing this goal.
Papers in this issue
We are pleased to publish four papers in this issue of the journal. All of the papers focus on an examination of underlying factors that contribute to economic and financial distress in countries, which is certainly an important and timely topic. The first paper is written by Eleftherios Giovanis and examines periods of both expansion and contraction in the US economy, including the severe contraction in 2007-2009 due to the mortgage market meltdown. The examination is based on two different approaches to predicting and identifying patterns in economic and financial fluctuations, with one being a logit model and the other a self-organizing map modeled on a neural network. In addition to providing empirical evidence on the likelihood of the financial crisis using data prior to 2007 and the likely length of the associated recession, the paper demonstrates the importance of using complementary methods to study business cycles and their patterns.
The second paper, by Sven Blank and Jonas Dovern, studies the interdependencies between a county’s financial system and its macro-economy when there is an aggregate shock to the former. This is done by developing a model that combines individual financial institution data and macroeconomic data for Germany, thereby allowing for interaction effects between the micro- and macro-levels in an economy. More specifically, one part involves formulating a probability of distress model for a bank that is linked to both institution-specific covariates and macroeconomic variables. The other part involves modeling the relationships among important macroeconomic variables. The two parts are combined to yield an integrated model. It is found that there is a close link between financial institutions and the macro-economy. It is also found that monetary shocks are the most influential shocks for distress among banks. More generally, the empirical results are taken to support an approach that integrates both the micro- and macro-levels in an economy.
Saurav Roychoudhury and Robert A. Lawson, in the third paper, consider the extent to which the degree of economic freedom in countries can explain the ratings of the sovereign debt issued by them. This assessment is supplemented with a similar analysis but with the spread between the yield on the securities issued by countries and the yield on US Treasury securities. Using the Economic Freedom of the World index published by the Fraser Institute, the empirical results indicate that countries with greater economic freedom benefit by being able to issue debt with higher credit ratings and lower yield spreads. This is particularly important now with so many countries responding to the financial crisis with calls for more regulation and restrictions that could reduce the level of economic freedom.
In the fourth paper, David G. Tarr provides a broad-based study of the financial crisis in the USA that led to worst recession since the Great Depression. It covers in a fairly detailed manner the key market, regulatory and political failures that triggered the crisis. The focus of the paper, however, is on the political economy reasons for the perverse incentives provided to real estate participants by the federal government. But discussing the causes of the crisis is not all that is done. Importantly, the paper also proposes some new and innovative ways to improve bank regulation to address the regulatory capture problem.
James Barth, John JaheraCo-Editors