The efficacy of macroeconomic policies in resolving financial market disequilibria: A cross‐country analysis

• Published date: 01 January 2019
• Author: Albert Wilson,Anwar Halari,Gurcharan Singh
• Date: 01 January 2019
• DOI: http://doi.org/10.1002/ijfe.1684

RESEARCH ARTICLE

The efficacy of macroeconomic policies in resolving

financial market disequilibria: A cross‐country analysis

Gurcharan Singh

1

| Albert Wilson

1

| Anwar Halari

2

1

Buckingham Business School, University

of Buckingham, Buckingham, UK

2

The Open University Business School,

The Open University, Milton Keynes, UK

Correspondence

Anwar Halari, The Open University

Business School, The Open University,

Milton Keynes MK7 6AA, UK.

Email: anwar.halari@open.ac.uk

Abstract

This study attempts to evaluate the efficacy of macroeconomic policies in

resolving financial market disequilibria and to elucidate the influence of the

political landscape and global financial integration on the policymaking pro-

cess. The current investigation examines three macroeconomic policies: (a)

government spending, (b) liquidity provision, and (c) central bank interest

rates by analysing 21 countries around the globe. The results suggest that gov-

ernment spending is a suboptimal macroeconomic policy for mitigating imbal-

ances in financial markets, as it may have destabilizing effects. Liquidity

provision was found to be ineffective in facilitating financial market stability

whereas the adjustment of interest rates was found to be a viable tool for

mitigating financial market imbalances. Therefore, an appropriate policy

framework would comprise the following: prudent government spending,

conditional liquidity provision, and a reduction in interest rates following the

development of financial market disequilibria. Furthermore, this study found

strong evidence against the notion that political orientations influence policy

frameworks, which were designed to redress financial market disequilibria.

This study also found that global financial integration does not influence the

policymaking process.

KEYWORDS

disequilibria, financial market, global financial integration, macroeconomic policies, political

landscape

1|INTRODUCTION

Following the 2008 financial crisis, policy frameworks

designed to mitigate financial market disequilibria and

economic downturns have been re‐evaluated in an

attempt to identify the role of macroeconomic policies in

supplementing macroprudential regulation (Blanchard,

Romer, Spence, & Stiglitz, 2012). A paradigm shift regard-

ing conventional policy frameworks that focus on core

economic objectives has occurred, with many countries

such as the United States, the United Kingdom, and

Japan providing unorthodox support to financial systems

through macroeconomic policies (Feenstra & Taylor,

2014). Given the dynamic and unpredictable nature of

financial systems, the task of designing and implementing

macroeconomic policies to resolve financial market

disequilibria and stimulate economies is particularly

challenging. Macroeconomic policies may also be subject

to the influence of the political landscape and global

financial integration, which may determine the choice

and efficacy of these policies (Soare, 2013).

The function of macroeconomic policies in resolving

financial market disequilibria has undergone a certain

degree of clarification in recent years (Blanchard et al.,

Received: 18 January 2018 Revised: 17 July 2018 Accepted: 10 September 2018

DOI: 10.1002/ijfe.1684

Int J Fin Econ. 2019;24:647–667. © 2018 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/ijfe 647

2012). Regarding fiscal policies, the use of government

spending as a stabilization tool in financial markets is

typically given more credence than tax policies (Delong,

Summers, Feldstein, & Ramey, 2012). Bachmann and

Sims (2012) postulated that increasing government

expenditure fosters confidence within financial markets,

which may alleviate any bottlenecks in the flow of

funds and help redress financial market imbalances.

However, Afonso and Sousa (2011) argued that govern-

ment spending shocks increase interest rates and displace

consumption and investment.

1

As for monetary policies,

many studies such as Mishkin (2011) and Gali (2013) pos-

ited that a viable policy framework to resolve financial

market disequilibria includes providing liquidity

2

and

adjusting interest rates or repo rates. Providing liquidity

and reducing interest rates may alleviate the funding

shortages of financial intermediaries, which increases

lending activities and helps mitigate financial market

disequilibria (Woodford, 2012). Other studies, however,

argue the low interest rate policy and excess liquidity lead

financial intermediaries to take excessive risks (Taylor,

2009). More specifically, Taylor (2009) criticizes the

monetary policies by central banks such as the U.S.

Federal Reserves that held interest rates too low for too

long in the run up to the 2008 financial crisis. Hence,

prior literature suggests that the primary macroeconomic

policies used to resolve imbalances in financial markets

may be government expenditure, liquidity provision,

and the adjustment of interest rates.

Macroeconomic policies are subject to the influence of

the political landscape, which may affect their efficacy in

mitigating financial market disequilibria (Soare, 2013).

The core objectives of macroeconomic policies are often

determined by the political ideologies of governments

and their electoral accountability (Fredriksson, Wang, &

Warren, 2013). Rausser, Swinnen, and Zusman (2011)

and Bjornskov and Potrafke (2011) postulated that politi-

cal ideologies determine the urgency attributed to finan-

cial market and economic issues, as objective economic

interests and subjective preferences vary across political

orientations. Fundamental to the left‐wing or liberal

perspective is the significant role of governments in

achieving distributive justice

3

(Hayek, 2012). Essentially,

left‐wing governments have a tendency to prioritize the

reduction of unemployment, implementing macroeco-

nomic policies primarily to restore economic stability,

facilitate an equal distribution of income and property,

and prevent market abuse (Hutchison, 2013). Conversely,

proponents of the right‐wing or conservative perspective

oppose intrusive government intervention (Bjornskov &

Potrafke, 2011). Right‐wing governments have an inclina-

tion to pursue price stability, with unemployment

being secondary in their macroeconomic objectives

(Thompson, 2014). Hence, right‐wing governments try

to facilitate market solutions before intervening. Suffice

to say, extremism in political ideologies is rare, as there

tends to be some convergence across the political

spectrum (Hutchison, 2013). Nevertheless, the political

landscape generates profound interference throughout

the policymaking process, determining the timing and

choice of macroeconomic policies implemented to miti-

gate financial market imbalances (Soare, 2013). As such,

the political landscape may influence the efficacy of

macroeconomic stabilization policies.

Beyond the political landscape, the choice of macro-

economic policies is also influenced by global financial

integration

4

(Corbett & Xu, 2015; Koenig & Zeyneloglu,

2010). Notwithstanding, the fact that global financial

integration encourages the flow of funds, it also increases

contagion or the exposure of financial systems to systemic

risks (Corbett & Xu, 2015). Many studies such as Feenstra

and Taylor (2014) and Karras (2014) argued that global

financial integration increases policy spillovers

5

between

countries, and governments tend to respond to these

externalities by implementing various macroeconomic

policies. Moreover, the efficacy of macroeconomic poli-

cies may also be partially contingent on the degree of

global financial integration (Mishkin, 2009). By increas-

ing arbitrage opportunities, global financial integration

may inhibit the real effects of expansionary fiscal policies

(Mishkin, 2009). As for monetary policies, global finan-

cial integration reduces the ability of central banks to

control market interest rates, intensifying the role of

exchange rates as policy transmission mechanisms

(Gadanecz & Mehrota, 2014). There has also been a grow-

ing consensus throughout the existing literature that

global financial integration induces the coordination of

macroeconomic policies across countries, led by a cohort

of countries such as the Group of Seven (G7)

6

(Feenstra &

Taylor, 2014). By impeding the efficacy of macroeco-

nomic policies and potentially reducing the level of

autonomy governments have in the policymaking pro-

cess, global financial integration can influence the choice

of macroeconomic policies that governments administer

(Feenstra & Taylor, 2014). Thus, global financial integra-

tion may have significant implications on the effective-

ness of macroeconomic policies implemented to resolve

financial market disequilibria.

The purpose of this study is to elucidate an effective

macroeconomic policy framework for resolving financial

market disequilibria, accounting for the influence of the

political landscape and global financial integration on

the choice of macroeconomic policies. As such, this study

aims to (a) determine the efficacy of macroeconomic

policies (government spending, liquidity provision, and

central bank interest rates) in resolving imbalances in

648 SINGH ET AL.