The Importance of Negative Feedback and Countervailing Measures for Financial System Stabilization and Constrained Inequality: A COVID-19–Induced Reminder

John L. Haracz

Chapter 3 in Financial Transformations Beyond the COVID-19 Health Crisis, 2022, pp 63-111 from World Scientific Publishing Co. Pte. Ltd.

Abstract: Positive-feedback mechanisms destabilize asset markets and promote wealth or income inequality. The COVID-19 pandemic exposed mispricing in asset markets and triggered a price crash. The pandemic also exacerbated inequality. Runaway positive-feedback mechanisms can be counteracted by implementing negative-feedback loops for financial system stabilization. Asset markets are sorely lacking the types of negative-feedback loops that promote stability and equilibrium in biological or engineering systems. For introducing negative feedback into asset markets, investors could be fed back the prevalence of destabilizing investment strategies. A rise in this prevalence would warn investors to exit overheated asset markets, thereby cooling off these markets endogenously. Price bubbles in overheated markets represent a market-failure mode, in which prices fail to closely track asset fundamental value. To prevent this failure, a market design should feed back the prevalence of investors’ destabilizing impulsive strategies, so traders could judge the degree of mispricing and voluntarily exit overheated markets. By exacerbating inequalities in income and health, the pandemic is also a reminder of the need for implementing countervailing measures to constrain inequality. These measures could include modest New-Deal–like programs that would be more readily implemented than the original New Deal in the US because existing government programs could be scaled up (e.g. housing vouchers for low-income renters, Medicaid, and the Earned Income Tax Credit). In summary, the widely recognized need for government spending in response to the pandemic should be seen as an opportunity to implement transformative measures aimed at stabilizing asset markets and constraining inequality.

Keywords: COVID19; Pandemic; Pandemic Outbreak; Health Crisis; Economics; Macroeconomics; Finance; Sustainable Finance; Financial Crisis; Financial Integration; Economic Integration; Global Financial Crisis; Financial Institutions; Corporate Finance; Corporate Governance; Board of Directors; ESG; Corporate Social Responsibility; Sustainable Finance; Stock Markets; Financial Markets; Stock Market Behaviour; Firm Liquidity; Emerging Markets; China; Financial Institutions; Money; Banks; Banking System; Banking Sector; Business Groups; Resilience; Safe Heaven; Gold; Oil; Peer-to-Peer Lending Market; Foreign Trading; Stock Market Volatility; Extreme Events (search for similar items in EconPapers)
JEL-codes: F4 F62 G15 G17 G3 O16 (search for similar items in EconPapers)
Date: 2022
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