Public Actors in Private Markets: Toward a Developmental Finance State

The nation’s recent financial crisis brought into sharp relief fundamental questions concerning the social function and purpose of the financial system, including its relation to the “real” economy. This Article argues that, to answer these questions, we must recapture a distinctively American view of the proper relations among state, financial market, and development. This programmatic vision – captured in what we call a “developmental finance state” – is based on three key propositions: (1) that economic and social development is not an “end-state” but a continuing national policy priority; (2) that the modalities of finance are the most potent means of fueling development; and (3) that the state, as the most potent financial actor, both must and often does pursue its developmental goals by acting endogenously – i.e., as a direct participant in private financial markets. In addition to articulating and elaborating the concept of the developmental finance state, this Article identifies and analyzes the principal modalities through which the modern American developmental finance state operates today. Finally, the Article proposes three broad strategic extensions of the existing modalities, with a view to enabling the emergence of a more ambitiously proactive and effective developmental finance state – and thus rediscovering a truly public-minded finance.

The Federal Funds Interest Rate Meets the Prime Rates

This paper explores the impacts of the Federal Funds Rate (FFR), a significant money market indicator, on the prime lending rates offered by commercial banks. Prior to 1994, the FFR had lagged effects on prime rates, but since the second quarter of 1994, the Federal Reserve Bank has implemented monetary policy which explicitly and publicly target the FFR. Commercial banks have since relied on the FFR to promptly modify the prime rate in response to changing policies. The results of the study signify that transparency in monetary policy targeting can facilitate desired effects, thereby increasing efficiency.

Excess Volatility: Beyond Discount Rates

We document a form of excess volatility that is irreconcilable with standard models of prices, and in particular cannot be explained by variation in the discount rates of rational agents. We compare behavior of prices to claims on the same stream of cash flows but with different maturities. Prices of long-maturity claims are dramatically more variable than justified by the behavior of short maturity claims. Our analysis suggests that investors pervasively violate the “law of iterated values.” The violations that we document are highly significant both statistically and economically, and are evident in all asset classes we study, including equity options, credit default swaps, volatility swaps, interest rate swaps, inflation swaps, and dividend futures.


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