The evolution of the U.S. financial architecture, asset prices, and the role of fiscal and monetary policy

Abstract

In the past years there has been increasing interest in shadow banking institutions. Economists identified the shadow banking system at the core of the 2007-2008 Global Financial Crisis and it was a key component of the transmission of fragility within the U.S. financial system. This study explains the emergence and growth of shadow banking institutions in the U.S. financial system and investigates the implications for monetary and fiscal policies. While the traditional banking literature puts the burden on the bank regulatory system implemented in the 1930s to explain the emergence of the shadow banking system, the discussion about the coordination between monetary policy objectives and regulatory policies designed to promote financial stability had received little or no attention. Competition between regulated and unregulated (or less regulated) financial institutions generated and allowed for the growth of new financial institutions (shadow banks) that attempted to escape regulations imposed by the New Deal reform. The banking reforms implemented in the 1930s implicitly required the coordination between monetary policy and the regulatory framework. The relationship between the growth of shadow banks and the relative importance of debt markets is further explored to investigate the effects of monetary policy on financial assets.