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25 November 2021

Regulators must act to prevent 'boom/bust' cycles in financial markets

Financial regulators should tighten monetary policy to prevent continued cycles of boom and bust in asset and housing markets, according to new research.

Researchers argue that regulators should act to prevent boom/bust cycles. Picture: STOCK IMAGE

A paper co-authored by Professor Engelbert Stockhammer, from King’s College London, presents evidence to support the view that regulators should ‘lean against the wind’ by acting sooner when price bubbles begin to form in markets.

Doing so could reduce the potential social harms that are linked to stock or housing market crashes.

The paper, Testing fundamentalist–momentum trader financial cycles: An empirical analysis via the Kalman filter, was co-authored with Dr Filippo Gusella, from the University of Florence, and was published in the journal Metroeconomica.

In the paper, the researchers present evidence to support Hyman Minksy’s theory on boom/bust cycles in equity and real estate prices, which, Minsky suggests, are endogenous and driven by the interaction of fundamentalist and momentum traders.

The paper also supports the work of prominent economist Robert Shiller, which suggests that asset price changes are not explained by an economic fundamental variation, but by the use of heuristics (short-cut behaviour).

The researchers examined data from the UK, France, Germany, and the US from 1970-2017.

They said: “The evidence presented in our paper suggests endogenous cyclical dynamics in financial asset markets. These financial cycles are likely to have real economic and social costs that occur not only to traders.

“The main policy implication of the paper thus is, fully in line with the suggestions of Hyman Minsky, that financial regulators need to lean against the wind and counteract financial boom-bust cycles.”

You can read the paper in full here.

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Professor of International Political Economy