Essays on financial instability and political economy of regulation

The Great Financial Crisis of 2007-2008 uncovered gaps in our understanding of financial stability, reshaping the research agenda of macroeconomics and finance. One of the key questions that emerged is what drives the build up of risk during the boom-phase of the financial cycle. The subsequent literature recognized the potential role of mistakes by investors and households, moral hazard faced by financial intermediaries and externalities associated with borrowing. Insufficient regulation, which can emerge as a consequence of political considerations, can be an important enabler for some of these mechanisms.
This dissertation comprises of papers that explore these themes. The first chapter studies how in the presence of moral hazard faced by banks balance sheet opacity may induce mistakes by other market participants and amplify a boom. The second chapter examines the role of voter preferences in shaping regulation aimed at curbing over-borrowing and alleviating future busts. The third chapter analyses how the structure of competition between interest groups affects politician’s choice of the form of political governance and the consequences for policy.