Mark S. Copelovitch

The Political Economy of the Euro Crisis

This article introduces the special issue on the political economy of the Euro crisis, which aims to improve our understanding of the causes, consequences, and implications of the highly unusual nature of this crisis: a financial crisis among developed countries within a supranational monetary union. The article provides a brief chronology of the crisis, discusses its underlying causes, and reviews the ways in which comparative and international political economy can help us understand the crisis. The article then discusses the individual and collective contributions of the articles in the special issue and discusses possible future research paths on the political economy of the Euro crisis. We conclude with a brief discussion of how a political economy perspective informs our understanding of the long-term prospects for the Eurozone and European integration.

Financial Regulation, Monetary Policy, and Inflation in the Industrialized World

This article argues that the institutional mandates of central banks have an important influence on inflation outcomes in the advanced industrialized countries. Central banks that are also responsible for bank regulation will be more sensitive to the profitability and stability of the banking sector and therefore less likely to alter interest rates solely on the basis of price stability objectives. When bank regulation is assigned to a separate agency, the central bank is more likely to enact tighter monetary policies geared solely toward maintaining price stability. An econometric analysis of inflation in 23 industrial countries from 1975 to 1999 reveals that inflation is significantly higher in those countries with central banks that are vested with bank regulatory responsibility, although this effect is conditional on the choice of exchange rate regime and the relative size of the banking sector. We also conduct a case study of the Bank of England, which lost its bank regulatory authority to a new agency in 1998. We find that the new Labour government under Tony Blair imposed the institutional change on the Bank of England in part to remove the bank stability bias from its monetary policymaking. These findings suggest that the mandates of central banks not only have important influences on macroeconomic outcomes, but may also be modified in the future by governments seeking to impose their own monetary policy preferences.

The International Monetary Fund in the Global Economy

The explosive growth and increasing complexity of global financial markets are defining characteristics of the contemporary world economy. Unfortunately, financial globalization has been accompanied by a marked increase in the frequency and severity of financial crises. The International Monetary Fund (IMF) has taken a central role in managing these crises through its loans to developing countries. Despite extensive analysis and criticism of the IMF in recent years, key questions remain unanswered. Why does the Fund treat some countries more generously than others? To what extent is IMF lending driven by political factors rather than economic concerns? In whose interests does the IMF act? In this book, Mark Copelovitch offers novel answers to these questions. Combining statistical analysis with detailed case studies, he demonstrates how the politics and policies of the IMF have evolved over the last three decades in response to fundamental changes in the composition of international capital flows.

Tipping the (Im)balance: Capital inflows, financial market structure, and banking crises

An emerging consensus among scholars and policy‐makers identifies foreign capital inflows as one of the primary determinants of banking crises in developed countries. We challenge this view by arguing that external imbalances are destabilizing only when banks face substantial competition from securities markets in the process of financial intermediation. We assemble a dataset of banking crises covering the advanced industrialized countries from 1976 to 2011 and find evidence of a conditional relationship between capital inflows, a well‐developed securities market, and the incidence of banking crises. We further explore the impact of capital inflows on banks’ actual risk taking as indicated by their capital adequacy levels and measures of insolvency risk. Our results demonstrate that prudential capital cushions tend to decline with the combination of capital inflows and prominent securities markets. We highlight the political decisions—often made during the early days of a countrys financial development—that determine the relative prominence of banks vs. non‐bank financial institutions and conclude with policy recommendations.

This Time Should Have Been Different: The Causes and Consequences of Macroeconomic Policy Failure in the Great Recession

The great tragedy of the last decade is that so much of the economic and political turmoil on both sides of the Atlantic has been unnecessary. Needless and excessive fiscal austerity, asymmetric inflation targeting, and the failure to address persistent sovereign and household debt overhangs have turned serious but manageable financial crises into long-term threats to the liberal international order. The real economic consequences have been massive: a “lost decade” for the Eurozone, a Great Depression in Greece, and below-trend income growth in the US and UK since 2008. Macroeconomic policies that might have resolved the crises quickly and accelerated the economic recovery – in particular, large-scale fiscal stimulus, with an emphasis on infrastructure investment generating substantial employment and taking advantage of historically-low (negative) real interest rates – were never even attempted. The political consequences of these fiscal and monetary “own goals” have been equally massive: a marked rightward political shift in many industrialized countries and a surge in populist nationalism, as illustrated most clearly in the cases of Brexit and the election of Donald Trump. This essay explores the reasons why policymakers failed so spectacularly, as well as the ramifications of this failure for the future of the global economy. It emphasizes two key factors: the persistence and pervasiveness of “bad” economic ideas, and the long-term, negative consequences of central bank independence. In a sort of Gresham’s Law of political economy, macroeconomic policy debates have been dominated by false narratives and discredited ideas, such as the household analogy, the morality of debt, and expansionary austerity. The prevalence of these narratives precluded any serious discussion of meaningful stimulus or debt relief on both sides of the Atlantic. This was especially tragic, given that we knew from history exactly what not to do in the wake of financial crises – and yet, we did it anyway. At the same time, central bank independence – while a successful institutional innovation to the inflationary problems of the 1970s and 1980s – proved to be a roadblock to effective monetary responses to the current crises. In particular, the widespread adoption of 2% inflation “ceilings,” along with the dominance of central bank governing boards by hawkish former bankers and economists, prevented serious discussion of more aggressive monetary policies that might have accelerated the recovery. This failure of macroeconomic policy and the ensuing era of stagnation has triggered a rising backlash against globalization. At the same time, we may now be seeing a counter-backlash, as those most dependent on cross-border supply chains and globalized financial markets increasingly speak out against Brexit, repealing NAFTA and other trade agreements, and increasing immigration restrictions. Despite fears of a rollback of globalization and the collapse of the liberal international order, the most likely medium-term outcome now seems to be increasing isolation of the US and UK, with the rest of the world’s major economies moving forward with continued trade and financial integration. The greater risk is that we will still not have fully recovered from the past decades crises when the next major crisis hits – and that we will once again fail to learn from our past macroeconomic policy errors when it does.

Financial Regulatory Transparency and Sovereign Borrowing Costs

How do markets discipline governments? The most direct way is through sovereign borrowing costs. Investors charge more interest when they anticipate that the risks of default increase. Where markets get their information from and how they use this information, however, is not well documented. In this paper, we argue that markets consider more than government balance sheets – they also consider the risks of the private financial sector to sovereigns. Investors, in turn, are more confident of their assessments for countries where bank regulators release detailed data on their financial sectors. To test this, we use a Dynamic Hierarchical Bayesian Item Response Theory to create a new, global, and comparable Financial Regulatory Transparency (FRT) Index. The Index is a unique measure of a country’s willingness to release minimally credible data on their financial system through international organizations. Using the FRT, we find that the effects of transparency are not always positive, but are instead conditional on a country’s public indebtedness. While more and increasing transparency lowers borrowing costs for highly indebted countries and countries that are reducing their debt, more transparency can increases the costs and volatility of those costs for countries with rapidly increasing debt.