Since the 2008/2009 global financial and economic downturn that has had profound implications for Grenada and other Caribbean states, several efforts have been underway to reform the international monetary system to make it more resilient to shocks and to lower the probability of another major financial crisis of the scope and magnitude witnessed seven years ago.
Among the initiatives proposed to reform the international monetary system were greater surveillance of economies worldwide by the International Monetary Fund, the creation of a new world reserve currency to replace the United States dollar as the main monetary unit in which international trade is conducted and significant changes in financial policies to strengthen financial systems throughout the globe to equip them with the necessary foundations to detect and avert major crises going forward.
It is certainly not the intention of this article to critically analyse the various reform initiatives that were proposed and implemented to bring about real changes in the international monetary system. Instead, this week’s contribution examines the issue of government’s intervention by way of policy changes to restore order to the financial system in times of a serious catastrophe by zeroing in on the role played by key political variables in shaping policy choices and consequently fiscal outcomes.
Theoretically, this area of investigation is important because of the heightened interest in the role of government since the most recent global recession and the extent to which intervention is necessary to regulate financial markets in particular and other markets in general.
The real question at hand is the extent to which lack of effective regulations and oversight by the United States’ federal government may have contributed to the bursting of the housing sector bubble in that country and the subsequent transmission mechanisms that gave rise to the 2008/2009 global financial and economic crisis.
Moving closer to home, we in Grenada and other Eastern Caribbean Currency Union (ECCU) members would have noticed several policy initiatives spearheaded by the Eastern Caribbean Central Bank (ECCB) to bring about changes in our financial system to hopefully avoid any major crisis in the near term. The most prominent of these changes is the reform of the Banking Act.
Even though it is reasonable to suggest that the ECCB does act with some degree of autonomy in relation to the regulation and supervision of our financial system, it is also safe to infer that our governments do have significant roles to play in any reform efforts because ultimately changes to, say, the Banking Act, cannot be done without the approval of the countries’ Parliaments. It is, therefore, from that perspective that political factors enter the discussions vis-a-vis their impact on policy choices.
Now, this writer has no empirical data with which he can objectively assess the role played by political considerations in reforming the financial system in the ECCU. However, your humble servant is in possession of a study that was done to address the very important question of the role played by political factors in determining government’s intrusion to soothe financial systems during episodes of banking predicaments throughout the world.
That 2015 study, under the caption: “The Political Economy of Financial Crisis Policy,” was done by Mícheál O’keeffe and Alessio Terzi. The beautiful aspect of the study is this: “We employ cross-country econometric evidence from all crisis episodes in the period 1970-2011 to examine the impact political and party systems have on the fiscal cost of financial sector intervention.”
The actual data used in the study comprised of 147 banking crisis episodes as well as the World Bank’s database of political institutions, encompassing numerous institutional and political factors for 178 countries from 1975 to 2012. Can we ask for more in terms of profundity of coverage and method of investigation?
Now, let’s cut through the chase. What did this study find? The major findings of the study, to quote the authors is: “Governments in presidential systems are associated with lower fiscal costs of crisis management because they are less likely to use costly bank guarantees, thus reducing the exposure of the state to significant contingent and direct fiscal liabilities. Consistent with these findings we find further evidence that these governments are less likely to use bank recapitalisation and more likely to impose losses on depositors.” Have you got this?
Finally, as a word of caution to the ECCB and our governments in the ECCU when contemplating new initiatives to reform our financial system, let us zero in on an important aspect of the overall conclusion of the study, which says: “Decision-making during financial crisis occurs under a lot of uncertainty and it is clear that financial crises upset old political economy equilibria. Therefore, a greater understanding of the impact that institutions and politics have on policy choices may allow us to better understand and predict decision-making in times of financial stress.”
Need I say more?
(Dr. Brian Francis, a former Permanent Secretary in the local Ministry of Finance, is currently a Senior Lecturer in the Department of Economics at the Cave Hill Campus in Barbados of the University of the West Indies)