The recent financial crisis will lead to a reform of banking supervision and regulation. The debate regarding this reform will include the question of concentrating monetary policy and supervisory policy functions in the central bank. Is the central bank the right institution to carry out both these functions? The traditional literature is against the attribution of supervision function to a central bank because it would damage the anti-inflationary credibility of this institution. However, even when central banks are goal independent, the time-inconsistency problem is not definitively solved: the government may remove previously granted central bank’s independence. The chance of this happening depends on its political costs, traditionally assumed to be exogenous. In reality, an independent central bank can use supervision as an instrument to break into these costs. In particular, a political exchange may arise between the central bank and commercial banks as an interest group. A central bank requires support and offers commercial banks favorable regulatory measures. The commercial banks offer their support to the central bank by exercising pressures on government in return for a favorable regulation. In this perspective the costs incurred by removing central bank’s independence become endogenous and depend on the behavior of this institution.
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