Europe between financial repression and regulatory capture. Bruegel Working Paper 2014/08, July 2014

From the Introduction. In the long shadow of the euro-area crisis, the relationship between governments and their banks has been brought to the the centre of the policy debate in Europe by the implementation of regulatory reforms, the risks associated with financial fragmentation, and the fight to sustain the flow of credit to governments and corporates. The attempt to interpret the patterns of pressure and influence running between governments and their financial system has led commentators to rediscover and give new life to concepts originating from academic debates of the 1970s such as “regulatory capture” and “financial repression”. Government agencies have been frequently described as being at the mercy of the financial sector, often allowing financial interests to hijack political, regulatory and supervisory processes in order to favouring their own private interests over the public good1. An opposite view has instead pointed the finger at governments, which have often been portrayed as subverting markets and abusing the financial system to their benefit, either in order to secure better financing conditions to overcome their own financial difficulties, or with the objective of directing credit to certain sectors of the economy, “repressing” the free functioning of financial markets and potentially the private interests of some of its participants2

The Financial Crisis and the Future of the Eurozone. Bruges European Economic Policy (BEEP) Briefing 21/2010

The government debt crisis, erupted in the Eurozone in 2009, nearly led to the collapse of European monetary union. Now that this has been averted, the question is what should be done to make the Eurozone sustainable in the long run. The survival of the Eurozone hinges on the capacity of its leaders to improve the eurozone's governance. With the exception of Greece, the root cause of the government debt crisis has little to do with the poor performance of the SGP, rather, with unsustainable debt accumulation by private actors. Also, the method of convergence implicit in the SGP has not worked well – macroeconomic divergences have stubbornly remained for nearly a decade and several countries experienced boom and bust dynamics. Although strong declines in real interest rates may explain part of the story (but e.g. Italy did not experience boom & bust), self-fulfilling waves of optimism and pessimism which might be called 'animal spirits' and are of mainly national origin, seem a good candidate for explanation. These national animal spirits endogenously trigger credit expansion and contraction. It follows that (national) movements of credit ought to be under much firmer control and this is up to the monetary authorities, including the ECB. Critical recommendations for better governance of the Eurozone should therefore combine credible measures to maintain fiscal discipline over the medium term with such instruments as minimum reserve requirements to control the growth of bank credit as well as minimum reserve requirements in different national banking systems. Finally, the idea of adding more sanctions to the SGP may be ill-conceived since, in future, it might pre-empt national governments to come to the rescue of banks (under credible threats of contagion) and/or prevent a downward spiral in economic activity.