Regulatory Cycles: A Political Economy Model

41 Pages Posted: 12 Mar 2018

See all articles by Pooya Almasi

Pooya Almasi

Georgetown University - Department of Economics

Jihad C. Dagher

International Monetary Fund (IMF) - Research Department

Carlo Prato

Columbia University - Department of Political Science

Date Written: March 7, 2018

Abstract

Financial regulatory policy in the U.S. has been conspicuously pro-cyclical over the last two decades. The 2000s financial boom coincided with a period of financial deregulation and the post-crisis response, a massive scaling up of regulation, was largely implemented during an economic downturn. Many argued that these regulatory waves were excessive. More recently, there are strong signs of a move toward deregulation, at a time of a booming economy and stock market. A closer look at historical financial boom-bust cycles suggests that, in fact, pro-cyclicality in financial regulation is a common and recurring pattern. This paper combines a signaling model of elections with a simple financial regulation model to study how public opinion, financial innovation, and policy-makers incentives shape financial regulation. While changes in voters' perceptions of financial innovation alone can generate a pro-cyclical pattern, we show that this cyclicality can be significantly amplified by politicians' electoral incentives: Both over-regulation and under-regulation can naturally arise in equilibrium, and small changes in public opinion can induce large regulatory shifts.

Keywords: Financial Regulation, Boom-Bust Cycles, Political Economy, Asymmetric and Private Information

JEL Classification: D72, D82, G18

Suggested Citation

Almasi, Pooya and Dagher, Jihad C. and Prato, Carlo, Regulatory Cycles: A Political Economy Model (March 7, 2018). Available at SSRN: https://ssrn.com/abstract=3136027 or http://dx.doi.org/10.2139/ssrn.3136027

Pooya Almasi

Georgetown University - Department of Economics ( email )

Washington, DC
United States

Jihad C. Dagher (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Carlo Prato

Columbia University - Department of Political Science ( email )

7th Floor, International Affairs Bldg.
420 W. 118th Street
New York, NY 10027
United States

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