Transcript GFC: Cause and consequences

The Global Financial Crisis:
Causes and Consequences
Warwick J McKibbin
CAMA, Australian National University
& The Lowy Institute for International Policy, Sydney
& The Brookings Institution, Washington DC
Presentation to Wednesday Lowy Lunch,8 April 2009
Overview
• Some Context:
– Understanding the World since 1997
• The Global Finance Crisis unfolding
– Key characteristics
• Understanding the nature of the crisis
– The main shocks
• Possible Scenarios looking Ahead
– Pessimism or optimism?
• The Global Macroeconomic Policy Response
• Summary and Conclusion
The Context
• From a project on understanding the global
financial crisis with Dr Andy Stoeckel using a
global economic model to understand the key
shocks
Philosophical Debate
• Populist view is that we need a new economic
framework and we need to throw away our
empirical knowledge of how economies work
• Alternative view is that our current frameworks
work well but we need to better understand the
nature of the shocks impacting on the world
3 observations
• Modern economies thrive on liquidity and
confidence
• The world is a complex place and it is unlikely
that there is a single cause of anything we
observe
• It is unhelpful to create simplified straw men and
cut them down one by one until there is nothing
left.
Major Shocks Since 1997
•
•
•
•
•
•
•
•
•
•
Asia crisis (1997/98)
Rising bond spreads 1999-2001
Dotcom bubble 98-2000 burst 2001
US monetary relaxation from 2001 to mid 2004
US monetary tightening mid 2004 to june 2006 then cuts from late
2007
Productivity surge in China manufacturing (relative price shock)
Rise in commodity prices, oil, food, 2004-late 2007
Bond spreads rise from mid 07
Stock markets peak in Oct 2007
Collapse of Lehman Bros - Collapse of stock markets; economic
growth and global trade
Asian Currencies against USD
December 1989 = 100, monthly
Index
Index
Singapore
125
125
Malaysia
100
South
Korea
100
Hong Kong
Taiwan
75
75
China
Thailand
50
50
Philippines
25
0
25
Indonesia
l l l l l
93
l l l l l l l l l l l l l l
97
01
05
09
Sources: Bloomberg; Thomson Reuters
l l l l
93
l l l l l
97
l l l l l l l l l l
01
05
09
0
Real GDP
Year-ended percentage change
%
%
Australia
6
6
4
4
2
2
Euro area
%
US
%
Asia*
5
5
0
0
Japan
New Zealand
-5
-10
-5
1996
1999
2002
2005
2008
* Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan
and Thailand
Sources: ABS; CEIC; Thomson Reuters
-10
US Share Price Indices
2 January 1995 = 100
Index
Index
600
600
NASDAQ
500
500
400
400
300
300
S&P 500
200
200
100
100
0
l
1995
l
l
1997
Source: Bloomberg
l
l
1999
l
l
2001
l
l
2003
l
l
2005
l
l
2007
l
2009
0
US Federal Funds Rate
%
8
%
8
7
7
Nominal
6
6
5
5
4
4
3
3
2
2
1
1
0
0
Real*
-1
-1
-2
l
l
1991
l
l
l
1994
l
l
l
1997
l
l
l
2000
l
l
l
2003
l
l
l
2006
l
-2
2009
l
* Real Fed Funds target calculated using core CPI updated to December 2008.
Sources: RBA; US Federal Reserve
Major Countries' Share Price Indices
Log scale, December 1994 =100
Index
350
300
Euro area
Index
350
300
Canada
US
250
250
200
200
150
150
Australia
UK
100
100
Japan
40
l
1995
l
l
1997
Source: Bloomberg
l
l
1999
l
l
2001
l
l
2003
l
l
2005
l
l
2007
l
2009
40
Rising Global Imbalances
• Global Savings in excess of global investment
– low long term real interest rates
• National savings and investment imbalances
– Countries with national savings greater than
national investment run current account
surpluses
– Countries with national investment greater
than national savings run current account
deficits
Current Accounts 1995-2008
(%GDP)
25
20
15
NIEs
Europe
ASEAN5
Middle East
China
USA
$bil
10
5
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-5
-10
Source IMF World Economic Outlook October 2008
Current Accounts 1995-2008
($US)
600
400
200
0
$bil
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-200
-400
-600
-800
-1000
Source IMF World Economic Outlook October
2008
NIEs
Europe
ASEAN5
Middle East
China
USA
Investment
50
45
40
35
%GDP
30
25
20
15
10
5
0
1995
1996
1997
Malaysia
1998
1999
Indonesia
2000
Thailand
2001
Korea
2002
2003
1
Main drivers behind the decline in current account balance in the
United States
Boom collapses
US dot com inv estment boom
0
-100
US fiscal deficit and
-200
public dissav ing, low
US$ billion ...
-300
personal sav ing rates
-400
-500
-600
Asian financial crisis and
-700
-800
loss of inv estor confidence
Japanese inv estment slump
-900
1991
1993
1995
1997
1999
Source: OECD Economic Outlook No. 76, December 2004
2001
2003
2005
Sources of current account imbalances
•
•
•
•
•
Fall in Asia investment
Fall in US (public and private saving)
Fluctuations in US investment
Rising oil prices
High Chinese savings relative to investment
Role of excess savings
• Search for yield
• Low real interest rates encouraging risk taking
led to apparent mispricing of risk
Emerging Market Bond Yields
%
%
Latin America
18
18
14
14
10
10
Asia
6
2
6
l
1995
l
l
1997
l
l
1999
l
l
2001
Sources: Bloomberg; Thomson Reuters
l
l
2003
l
l
2005
l
l
2007
l
2009
2
Relative Price shocks
• Fall in relative price of manufacturing relative to
commodities
• Rise in relative price of future consumption
relative to current consumption (a rise in risk)
• Rise in inflation globally from loose global
monetary policy but lags in relative price
adjustment
Commodity Prices in $US
(Index = 100 in 2003M1)
500
450
400
350
300
250
200
150
100
50
20
03
20 M1
03
20 M4
0
20 3M7
03
M
20 10
04
20 M1
04
20 M4
04
20 M7
04
M
20 10
05
20 M1
05
20 M4
0
20 5M7
05
M
20 10
06
20 M1
06
M
20 4
06
20 M7
06
M
20 10
07
20 M1
07
20 M4
0
20 7M7
07
M
20 10
08
20 M1
08
M
20 4
08
M
7
0
Source: IMF World Economic Outlook Database October
2008
Energy
Food
Agricultural Raw Materials
Metals
Beverages
Preliminary model results
• Energy/commodity price hikes from 2004
• 1/3 due to the emergence of rapidly growing
developing economies
• 1/3 due to the lagged effects of loose US
monetary policy through fixed exchange rates on
global liquidity
• 1/3 due to speculation
The Global Financial Crisis
• Contraction of the US Housing market (excess capacity)
• Massive de-leveraging by financial institutions with MBS
exposure
– Transparency problems in securitized assets
(regulatory breakdown)
• Lehman Bros collapse Sept 2008
• Credit markets freeze due to unknown counter party risk
• US and UK Governments slow to react to loss of
confidence – Paulson plan
• Stock market slump and housing price decline reduces
consumption and investment
• Recession in the industrial world
• Recession globally
US Corporate Bond Yields (3-5 years)
Monthly
%
%
9
9
BBB corporates
7
7
Swap
5
5
AAA
corporates
3
3
US government
1
1997
1999
Source: Bloomberg
2001
2003
2005
2007
2009
1
US Corporate Bond Spreads (3-5 years)
Spread over government yields, monthly
Bps
Bps
800
800
600
600
AAA corporates
400
400
BBB corporates
A corporates
200
200
Swap
0
1997
1999
Source: Bloomberg
2001
2003
2005
2007
2009
0
What is the core of the latest crisis?
• Collapse in US housing market – reducing
household wealth and consumption
• Rise in risk
• Existing capital requires a higher return
• Need to scale back capital
• Fall in equity markets also reduces wealth
• Rise in household risk premia reduces future
income streams
A example from the G-Cubed model
See
www.gcubed.com
Equity Risk Shock
• Suppose equity risk premia rise by 8% forever
• Versus equity risk premia rising 8,6,4,2,0
Change in US Real GDP from 8% equity risk premium
0
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21
-1
%deviation
-2
-3
-4
-5
-6
Temp
Permanent
Change in US Capital Stock from 8% equity risk
premium
2
0
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21
-2
-4
-6
-8
-10
-12
-14
-16
-18
Temp
Permanent
Household Risk Shock
• Suppose household discount them future at 4%
per year forever
• Household discount rate rises 4,2,0…..
Change in US Consumption from 4% household risk
premium
8
6
4
2
-4
-6
-8
-10
-12
-14
72
68
64
60
56
52
48
44
40
36
32
28
24
20
16
12
8
-2
4
0
%deviation
0
Permanent
Temporary
Change in US Real GDP from 4% household risk
premium
2
0
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21
%deviation
-2
-4
-6
-8
-10
Permanent
Temporary
Core Shocks
• In the US and UK it is a financial crisis
• In other countries it is a fall in exports and a loss
of domestic confidence
• This is both a supply side shock and a demand
side shock not just insufficient demand
On the global policy responses
• In a single economy
– Monetary policy effective
– Fiscal policy less effective
• In a global economy
– Coordinated monetary policy less effective
– Coordinate fiscal policy more effective
• Temporary fiscal policy more effective than permanent
fiscal policy
– Composition matters for supply versus demand
response
Role of Policy
• Monetary policy shifts demand from the future to
the present
• Fiscal policy largely shifts demand from the
future to the present plus it can change
incentives to invest and save with permanent
effects on the level of income
3 Scenarios
• Risk premia remain high
– Long process of capital destruction
– Demand stimulus can’t change this but can
soften the blow
Early signs of recovery?
• Optimism
– Commodity prices slightly rising
– Chinese foreign investment rising
• Pessimism (and key risks)
– European economies fiscal liabilities putting
strain on the Euro
– Eastern Europe looking more like East Asia in
1997
2 scenarios
• 1) Risk returns to pre 2007 levels
– Strong recovery with demand stimulus
overlaying
– Governments have borrowed heavily and now
need to finance large deficits
– Rising global interest rates as public and
private compete
3 scenarios
• 2) Risk premia fall to back to 1990s levels
• US and UK in long asset adjustment period
• Developing countries return to growth
momentum quickly
Summary and conclusion
• A series of shocks over the past decade but the big
shock is a loss of confidence (risk shock)
• Large financial and real implications of this type of shock
• Trade is not the major channel of transmission but the
problem is a synchronized loss of confidence
• Monetary and fiscal policies can’t do much to stabilize
the supply side but can help smooth demand in the short
run
• Macro policy’s main role is to raise confidence rather
than as an end in itself
• Regulatory reform and institutional reform is critical for
handling future shocks
www.sensiblepolicy.com