Financial Market Diversity and Macroeconomic strongStabilitystrong.pdfVIP

Financial Market Diversity and Macroeconomic Stability Christian E. Weller Professor Department of Public Policy and Public Affairs McCormack Graduate School of Policy and Global Studies University of Massachusetts Boston 100 Morrissey Boulevard Boston, MA 02125 Email: Christian.weller@ and Senior Fellow Center for American Progress Washington, DC and Ghazal Zulfiqar Department of Public Policy and Public Affairs University of Massachusetts Boston Abstract Macroeconomic instability has stunted growth in many developing economies in the past two decades. As a result, the governments of these economies are looking for ways to better manage the economic factors that contribute to instability. Encouraging the creation of diverse financial markets, characterized by a wide range of financial institutions, may be one such option for better macroeconomic risk management . Greater institutional diversity could broaden the reach of financial markets, thus reducing liquidity constraints. And diversity may offer some insurance against the fallout from boom-and-bust cycles in each institutional type since each institutional type only covers a limited market segment. But greater institutional diversity could contribute to instability. Many institutions may not fully capture economies of scale, driving up costs and fees for customers and exacerbating liquidity constraints. This may especially be the case if governments try to incentivize the creation of institutions in otherwise underserved markets through regulatory preferences and subsidies. Institutions may also compete for a limited number of creditworthy p