Financial Stability and Policy Cooperation

Banco de Portugal Occasional Papers 1/2010

48 Pages Posted: 2 Oct 2013

See all articles by Vítor Gaspar

Vítor Gaspar

Bank of Portugal

Garry J. Schinasi

Independent Advisor, Global Financial Stability

Date Written: July 1, 2010

Abstract

Within the context of the Global Crisis, this paper examines the ongoing policy challenges in establishing a European framework for financial regulation and supervision. We do so taking into account the evidence provided during the crisis of pervasive spillover effects and cross-country interdependence. The paper applies game-theoretic models as tools to think about the cross-country aspects of European financial integration over time. Specifically, the paper applies the economic theory of alliances of Olson and Zechauser (1966) and the private provision of public goods of Bergstrom, Blume and Varian (1986). We contrast the noncooperative Nash equilibrium allocation with cooperative (Coase) outcomes. The latter can be expected to obtain under zero transaction costs. We follow Coase in taking zero transaction costs as a benchmark to examine the factors that may favor (or hinder) cooperation in specific circumstances. We consider the importance of iterated interactions through the theory of repeated games, case studies, and experimental evidence to identify factors favoring or hindering successful cooperation. The total number of participants, time, foresight, multiple equilibria, leadership, the magnitude and volatility of gains and losses, imperfect and asymmetric information, decision and bargaining costs, monitoring, and enforcement are all important factors. In the paper we stress the importance of an institutional approach that minimizes obstacles to reaching cooperative outcomes. We highlight the need for effective procedures to deal with systemic risk, an agreed set of rules underpinning the single European financial market (e.g. state aid rules and a single rule book), and effective restructuring, resolution and crisis management mechanisms.

Keywords: policy cooperation, European Union, financial stability, game theory

JEL Classification: F02, E61, H41, C72, D70

Suggested Citation

Gaspar, Vítor and Schinasi, Garry J., Financial Stability and Policy Cooperation (July 1, 2010). Banco de Portugal Occasional Papers 1/2010. Available at SSRN: https://ssrn.com/abstract=1645801

Vítor Gaspar

Bank of Portugal ( email )

Rua Francisco Ribeiro, 2
Lisbon, 1150-165
Portugal

Garry J. Schinasi (Contact Author)

Independent Advisor, Global Financial Stability ( email )

Washington, 20008
+1-202-361-0958 (Phone)

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