By Simon Johnson, Peter Boone. Johnson is Professor of Entrepreneurship, Sloan School of Management, MIT and CEPR Research Fellow. Boone is Research Associate, Centre for Economic Performance, LSE. Originally published at VoxEU .
Industrialised countries today face serious risks – for their financial sectors, for their public finances, and for their growth prospects. This column explains how, through our financial systems, we have created enormous, complex financial structures that can inflict tragic consequences with failure and yet are inherently difficult to regulate and control. It explains how this has happened and why there are more and worse crises to come.
There is a common problem underlying the economic troubles of Europe, Japan, and the US: the symbiotic relationship between politicians who heed narrow interests and the growth of a financial sector that has become increasingly opaque ( Igan and Mishra 2011 ). Bailouts have encouraged reckless behaviour in the financial sector, which builds up further risks – and will lead to another round of shocks, collapses, and bailouts.
This is what we have called the ‘doomsday cycle’ (Boone and Johnson 2010). The cycle turned in 2007-8 and was most dramatically manifest in the weeks and months that followed the fall of Lehman Brothers, the collapse of Iceland’s banks and the botched ‘rescue’ of the big three Irish financial institutions.
The consequences have included sovereign debt restructuring by Greece, as well as continuing problems – and lending programmes by the IMF and the EU – for Greece, Ireland, and Portugal. Italy, Spain and other parts of the Eurozone remain under intense pressure.
Yet in some circles, there is a sense that the countries of the Eurozone have put the worst of their problems behind them. Following a string of summits, it is argued, Europe is now more decisively on the path