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Finance and Monetary Policy beyond Neo-liberalism
Against the backdrop of the North Atlantic financial crisis that erupted in 2007–08, this article looks into the changing role of central banks and the monetary and financial sector policies and the challenges of managing the tensions of this impossible trinity, especially from the standpoint of the emerging market economies. Lessons derived from the crises observed in the past three to four decades, whether in the emerging markets or the advanced economies, suggest that financial markets are inherently unstable. Hence, the article concludes that the emerging economies need to practice enhanced and active surveillance of their financial sector in their quest for maintaining of high growth along with financial stability.
This article has benefi tted from comments by Homi Kharas on earlier draft.
Broad consensus had been achieved around the dominant neo-liberal thinking in relation to financial sector regulation and monetary policy in the two decades leading up to the North Atlantic financial crisis (NAFC) that erupted in 2007-08. Whereas this thinking was essentially developed and applied in the advanced economies (AEs), similar policy prescriptions were advocated for emerging market economies (henceforth, emerging markets [EMs]). The general view was based on two theoretical propositions: the efficient markets hypothesis (EMH) and the rational expectations hypothesis (REH).
“The EMH defines an efficient financial market as one in which securities prices fully and rationally reflect all available information” (Turner 2016: 37). The REH “proposed that individual agents in the economy—be they individuals or business- es—operate on the basis of rational assessments of how the future economy will develop” (Turner 2016: 38). Based on the belief that financial markets operate efficiently, it was assumed that free competition in financial markets would result in the efficient allocation of capital across the economy, and hence promote growth. And belief in the REH suggested that both individuals and financial institutions are capable of managing risks. The corollary was that regulation should be “light touch” only (Group of Thirty 2015: 9).
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