Financial Innovation

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Abstract
Financial Innovation has been the backbone of our modern financial system. It has revolutionised the way we spend, receive and borrow money, however through the recent global financial crisis and negative connotations that have been attached to the term, people have doubted the positive notions it has had. It is important to distinguish between innovation itself and how it can be used or misused. Recent Financial Innovation has thwarted real economic growth and has been the blame for the recent global financial crisis and having an affect on microeconomic behaviour. The failure for governments to impose strict regulations, such as monetary policy, has had a negative consequence on financial innovation and on the financial system. Although innovation has indeed lead to strong economic performance in times, the meaning of innovation has somewhat been remodeled from one that had a core function of improving efficiency and to promote growth accomplishing broader societal functions to one that is misaligned. Therefore in this essay I discuss why we need financial innovation but why regulation is needed to prevent such economic loss and why enforcement to prevent future economic disasters is needed.

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Financial Innovation Essay
Exchange traded funds, the growth of venture capital, and easier access to our money, all of these are financial innovations that have had a positive notion on economic growth. However the phrase “financial innovation” has been branded with a negative connotation. In recent times it has faced much scrutiny, so much so that some financiers have come to conclusion that it is an ineffectual concept and that the potential benefits it has are more or less a potential disadvantage to economic growth in the long run. This concept has divided many financiers, where they hold a generalised opinion that the development of new financial instruments have created opportunities for households and companies, and to impose regulations on financial innovators will see negative implications on economic growth and future economic prosperity.1 In this essay I will summarise both the positive and negative aspects of financial innovation on the economy. In addition to this I would like to outline whether imposing restrictions by governmental authorities on financial institutions is a wise choice and if this is the case, to what extent should regulation be enforced. Initially I believe that financial innovation has enabled growth of the economy and has brought about many benefits, but I believe that financial regulation has been incorrectly implemented and enforced. This is seen by the instances discussed in this essay. To understand “Financial Innovation” we must first define what it means. According to Malcolm Tatum, the term is used to “describe the generation of new and creative approaches to different financial circumstances and is used in relation with creating

1 Jenkinson N, Penalver A, Vause N, (2008) “Financial Innovation: What Have We Learnt?” pp.31 & 32

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new types of securities. At other times, it has to do with new approaches to investing or management of money”.2 To begin, we consider views on financial innovation. A recent quote from Paul Volcker, who is a well respected American economist, chairman of the federal reserve in the United States and one who served many American presidents including Jimmy Carter, Ronald Reagan and currently Barack Obama recently said, “I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy. Maybe you can show that I am wrong. All I know is that the economy was rising very nicely in the 1950s and 1960s without all of these innovations. Indeed, it was quite good in the 1980s without credit default swaps and without securitisation and without CDOs.” 3 The second statement comes from Princeton professor and economist writer of the New York times Paul Krugman....
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