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Jihad Dagher
Financial crises are traditionally analyzed as purely economic phenomena. The political economy of financial booms and busts remains both under-emphasized and limited to isolated episodes. This paper examines the political economy of financial policy during ten of the most infamous financial booms and busts since the 18th century, and presents consistent evidence of pro-cyclical regulatory policies by governments. Financial booms, and risk-taking during these episodes, were often amplified by political regulatory stimuli, credit subsidies, and an increasing light-touch approach to financial supervision. The regulatory backlash that ensues from financial crises can only be understood in the context of the deep political ramifications of these crises. Post-crisis regulations do not always survive the following boom. The interplay between politics and financial policy over these cycles deserves further attention. History suggests that politics can be the undoing of macro-prudential regulations.
Deniz Anginer, Mr. Eugenio M Cerutti, and Mr. Maria Soledad Martinez Peria
This paper examines the association between the default risk of foreign bank subsidiaries in developing countries and their parents during the global financial crisis, with the purpose of determining the size and sign of this correlation and, more importantly, understanding what factors can help insulate affiliates from their parents. We find evidence of a significant and robust positive correlation between parent banks’ and foreign subsidiaries’ default risk. This correlation is lower for subsidiaries that have a higher share of retail deposit funding and that are more independently managed from their parents. Host country bank regulations also influence the extent to which shocks to the parents affect the subsidiaries’ default risk. In particular, the correlation between the default risk of subsidiaries and their parents is lower for subsidiaries operating in countries that impose higher capital, reserve, provisioning, and disclosure requirements, and tougher restrictions on bank activities.
Yoko Shinagawa
This paper defines financial market spillovers as the comovement between two countries’ financial markets and analyzes financial market spillovers over the period 2001-12 through four channels: bilateral portfolio investment, bilateral trade, home bias, and country concentration. The paper finds that, if a country has a large amount of bilateral portfolio exposure in another country, these two countries’ comovement of bond yields are large. Also, countries’ geographical preferences impact financial spillovers; if a country has a stronger home bias, the country could have less spillovers from foreign financial markets. A policy implication from this result is that, if countries become less home-biased and have a greater amount of portfolio investment assets, they should strengthen prudential regulations to mitigate against rising risks of financial spillovers (or risk greater volatility owing to comovement with foreign markets).
Ms. Yan M Sun, Ms. Pritha Mitra, and Mr. Alejandro Simone
This paper studies the factors behind pro-cyclical but widely varying construction shares (as a percent of GDP) across countries, with a strong focus on European countries. Using a dataset covering 48 countries (including advanced and emerging economies within and outside Europe) for 1990-2011, we find that country’s geography, demographics, and economic conditions are the key determinants of a norm around which actual construction shares revolve in a simple AR(1) and error-correction process. The empirical results show that in many European countries, construction shares overshoot relative to their norms before the recent global crisis, but they have fallen significantly since the crisis. Nevertheless, there is still room for further adjustment in construction shares in some countries which may weigh on economic recovery.
Ouarda Merrouche, Ms. Enrica Detragiache, and Asli Demirgüç-Kunt
Using a multi-country panel of banks, we study whether better capitalized banks experienced higher stock returns during the financial crisis. We differentiate among various types of capital ratios: the Basel risk-adjusted ratio; the leverage ratio; the Tier I and Tier II ratios; and the tangible equity ratio. We find several results: (i) before the crisis, differences in capital did not have much impact on stock returns; (ii) during the crisis, a stronger capital position was associated with better stock market performance, most markedly for larger banks; (iii) the relationship between stock returns and capital is stronger when capital is measured by the leverage ratio rather than the risk-adjusted capital ratio; (iv) higher quality forms of capital, such as Tier 1 capital and tangible common equity, were more relevant.
International Monetary Fund

Spain’s 2007 Article IV Consultation underlies that immediate growth prospects are bright and the central scenario is for a smooth landing but with appreciable downside risks. The Spanish economy enjoyed another year of remarkable growth in 2006, further extending its prolonged expansion. Output growth gathered pace in the course of 2006 to reach 3.9 percent for the year, and brisk job creation absorbed further increases in female participation and immigration, and inflation moderated appreciably.

International Monetary Fund
This note assesses the risk profile of the nonfinancial equity investments of Spanish credit institutions (CIs), based on a market-risk approach. It assesses the main features of the situation and indicates the problems of CIs’ nonfinancial equity investments. It presents the evolution of nonfinancial equity investments, and their importance for the economy. It analyzes using the value-at-risk (VaR) approach and recommends enhancing of risk management practices and surveillance with regard to CIs with a significant nonfinancial equity investment, and encourages those CIs to adopt the market-based approach.
International Monetary Fund
This Selected Issues paper of Portugal highlights the discussions on the requirement of policies to overcome structural and cyclical impediments to growth, and secure fiscal consolidation. It analyzes the strength of the company balance sheets in supporting the rebound from recession, and also the links between corporate balance sheet strength and investment. It reviews the challenges in the Portuguese economy, the impact of European Union enlargement on Portuguese trade, the pension prospects, and the implications of various policy reform scenarios.
Mr. Thomas Kraus
Using symmetric data sets of 92 weekly return observations before and after the introduction of the euro, the paper analyzes the impact of the new currency on the return structure of equity markets in the European Monetary Union. Variance decompositions, cluster analyses, and principle component analyses are used to explore the changes in the structural relations. European industry factors are found to have dramatically increased in importance with the launch of the single currency, and a new 'country-size' factor in European stock returns is detected. Furthermore, inner-European correlations are documented to have been reduced sharply with the start of the monetary union.