Working Paper: CEPR ID: DP10015
Authors: Ouarda Merrouche; Erlend Nier
Abstract: This paper investigates empirically three potential drivers of financial imbalances ahead of the global financial crisis: rising global imbalances (capital flows); loose monetary policy; and inadequate supervision and regulation. We perform panel data regressions for OECD countries from 1999 to 2007 to explore the relative importance of these factors, as well as the extent to which they might have interacted in fuelling the build-up. We find that the build-up of financial imbalances was driven by capital inflows and an associated compression of the spread between long and short rates. The effect of capital inflows on the build-up was amplified where the supervisory and regulatory environment was relatively weak. In contrast, differences in monetary policy did not significantly affect differences across countries in the build-up of financial imbalances ahead of the crisis.
Keywords: global imbalances; monetary policy; supervision and regulation
JEL Codes: E5; F3; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Capital inflows (F21) | Expansion of financial imbalances (F65) |
| Weak supervisory and regulatory environment (G28) | Amplified effect of capital inflows on financial imbalances (F65) |
| Differences in monetary policy (E49) | Buildup of financial imbalances (F65) |
| Stronger supervisory powers (G28) | Reduced buildup of financial imbalances (F65) |
| Capital inflows + Supervisory strength (F21) | Dynamics of financial imbalances (F65) |