Financial Interconnectedness and Systemic Risk

The financial crisis introduced the idea that some banks are “too big to fail.” It was not just their size, but their interconnectedness that proved disastrous—shocks suffered by large banks spread quickly throughout the financial system, and then to the whole economy. The Federal Reserve has begun disseminating data on large banks and intra-financial activity. The blog Naked Capitalism features a post by Nikhil Rao, Juan Montecino, and PERI Co-Director Gerald Epstein. They examine an unprecedented level of detail in the Fed’s new report—and find that seven of the largest banks are also the most interconnected. 

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Savings, Capital Flight, and African Development

Historically, countries that achieve and sustain high growth rates maintain high domestic saving rates, enabling domestic investment and job creation. But saving in African countries has remained low, leading to high investment-savings gaps, and increased dependence on external capital. This analysis by Léonce Ndikumana, Director of PERI’s African Development Policy Program, suggests that strategies to address domestic savings should include policies to curb and prevent further capital flight (the leakage of financial resources) from Africa, the levels of which have exploded over the past decade.

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The Causes of China’s Export-Led Growth

There is consensus among economists, international organizations and the Chinese government that China’s export- and investment-led growth model is unsustainable. Exchange rate manipulation is often named as the major cause of China’s massive trade surpluses. But there is no agreement about the extent to which the Renminbi is actually undervalued, and if an exchange rate appreciation would significantly reduce China’s current account surplus. In this working paper, Simon Sturn finds that the central policy challenge for correcting China’s trade imbalances is not simply to appreciate the Renminbi, but to increase reduce inequality and increase average household incomes.  This will increase China’s domestic consumption level relative to exports.

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Asset-Based Reserve Requirements: A More Effective Exit Strategy for the Fed

The Federal Reserve’s current policy of quantitative easing—buying financial assets from commercial banks and other financial institutions, thereby increasing the monetary base in order to stimulate the economy—has resulted in effectively giving banks a tax cut at the public’s expense, and risks domestic and financial market turmoil. This paper by Thomas Palley argues that an alternative strategy based on asset based reserve requirements would be less expensive, more effective, and could help shrink the outsized financial sector.

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Shadow Banking and Systemic Risk in China

Systemic risk occurs when many financial institutions fail due to a common shock. The US and Europe faced both liquidity and solvency risk in the recent crisis, but China did not. Since China has not faced a system-wide meltdown, it is not obvious where the weaknesses within China’s shadow banking sector may lie. This paper by Sara Hsu, Jianjun Li, and Ying Xue uses a Markov analysis to find that some systemic risk is presented by trust companies, and that banks absorb most of this risk in the financial system.

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