5 - Financialization of European Economies

Summary

The credit market plays an essential role in financing European companies. In 2004, stock market capitalization accounted for 53% of Euro zone GNP. The size of the banking sector and the depth of the intermediation process are also considerable: bank assets compared with GNP reached almost 281%. Domestic credit to the private sector (compared with GNP) represents 114%. This strong shift towards financialization today comes hand in hand with enhanced variability of inflation. We can, however, ask ourselves if inflation is still the only factor to provide a relevant indicator of economic fluctuations’ overheating: what about financial assets’ influence?

The current context of financial instability affecting economic agents requires that we again question the types of expectations they are making. In the systemic analysis of H. P. Minsky, the free play of individual behaviour and the competitive environment lead agents to create their own instability. But it is also because banks are capable of financing themselves that a true imbalance can occur. This second financing mode, which interacts with bank credit, has consequences on the nature of agents’ expectations. If the Central Bank continues today to limit the credit supply of commercial banks, the fact that the latter are increasingly turning to the markets to finance themselves creates further uncertainty. The ignorance facing economic agents drives them to develop herding behaviour (Section 1).

We aim to verify that this behaviour results above all in self-fulfilling expectations of the real price of assets. Based on a database supplied by the Bank for International Settlements (elaborated by S. V. Arthur, C. Borio and P. Lowe) we introduce the evolution of the real price of assets in Wicksellian rate differentials aimed at recounting the direction taken by the business cycles of four European countries (Germany, Spain, France and Italy). Our results tend to show that a reduction of the monetary interest rate is a warning signal for long-term growth cycles. The latter, are then clearly illustrated by the agents’ expectations of the evolution of the real price of assets (Section 2).