Financial crisis begets financial reform? The origin of the crisis matters

- Assess whether financial crisis begets financial reform
- Need to distinguish domestic financial crises and external financial crises
- Recent research on gross financial flows helps making the distinction.
- Different origins of crises affect different dimensions of reform.
- Need to pay more attention to the origin of crises empirically and theoretically

The empirical literature assessing whether crisis begets reform has paid little attention to the role of the origin of crises. This paper considers seven dimensions of financial reform, as well as an aggregate index of these dimensions, and focuses on crises defined as sudden stops in financial flows. Recent work on gross financial flows provides a suitable strategy to distinguish between domestic crises (sudden flight) and external crises (true sudden stops). While the origin of the crisis plays no role in explaining the likelihood of reform in the case of the aggregate index of financial reform, different origins of crises affect different individual dimensions of financial reform. Thus, the origin of the crisis matters when assessing the nexus between financial crisis and financial reform. The evidence is particularly compelling for the case of sudden flight and reform of capital account restrictions, and more tentative for the case of true sudden stops and reform of banking regulation and supervision. These findings underscore the need to pay greater attention to the origin of crises in empirical work focusing on the relationship between financial crisis and financial reform, and also in theoretical models of the political economy of financial reform.