Edited by John Grahl
Chapter 14: Financial Stability
Dominique Plihon INTRODUCTION Financial stability is a public good – in the same way as health, education, knowledge, environment and peace – because it is indivisible and nonexclusive, that is it benefits all players and all countries. In a symmetrical way, financial instability is an international public bad because it creates important negative externalities: the bankruptcy of individual banks or investors can lead to crises at the national and international levels. This is known as ‘systemic risk’, a well-known phenomenon in international finance. The cost of resolving such global crises is paid by taxpayers, although of course the total social costs may be much higher than these expenditures. The international financial stability which characterized the first decades after World War II disappeared in the 1970s with the generalization of flexible exchange rate regimes caused by the breakdown of the Bretton Woods monetary system. Financial instability increased sharply in the 1990s due to the globalization process, which led to a very high mobility of capital, to very much larger international capital flows and to the explosive growth of financial markets in the world economy. Many empirical studies have shown the high correlation between financial instability and the accelerated process of financial deregulation which was decided by major industrial countries and imposed on developing countries during the last two decades.1 The demand for international public goods, such as financial stability, has grown along with globalization. But their supply remains restricted because governments, central banks and businesses are acting in isolation; they do not take...
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