Leverhulme Centre 6th Form Conference,
June 26th 2012
The Global Financial Crisis and the World
Economy
Professor David Greenaway
And some films…….
Context and Origins
Origins
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Capital market liberalisation
Global macro imbalances
Global savings glut
Accomodative monetary policy
Strong global growth
The ‘end of boom and bust’
The search for yield and underestimation of risk
Regulatory vacuums
From Sub-Prime Crisis to
Credit Crunch
What is Sub-Prime Lending?
Sub-prime borrowers typically have weakened
credit histories that include payment
delinquencies, and possibly more severe
problems such as charge-offs, judgements and
bankruptcies. They also display reduced
repayment capacity as measured by credit
scores, debt to income ratios, or other criteria
that may encompass borrowers with incomplete
credit histories.
US Treasury Department guidelines, issued
in……. 2001
Why Did We Have a Sub-Prime
Crisis?
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An international savings glut
Low interest rates and liquid financial markets
Search for yield
Ever more sophisticated, but ever more opaque,
financial engineering
• Underestimation of risk
• Inflation in asset values, especially real estate /
housing
• Housing price slowdown and contagion in 2007 /
2008
Why Do We Have a Credit
Crunch?
• Information ‘black holes’
– uncertainty over the magnitude of toxic debt
– uncertainty over the location of toxic debt
• Banks stopped lending to each other
– uncertainty over the location of toxic debt
– uncertainty over their own exposure
• Banks cut back on retail lending
– provision for write-offs
– need to rebuild balance sheets
Policy Responses
Government Intervention
• Interest rate cuts:
– United States (5.25 to 0.3%)
– Eurozone (4.25 to 1.0%)
– United Kingdom (5.75 to 0.5%)
• Support for the financial system:
– US, UK and Eurozone: $8,995 billion (and
rising)
• Liquidity support: $1,950 billion
• Asset purchases: $2,525 billion
• Guarantees: $4,480 billion
‘The Aftermath of Bankning
Crises’
‘The Aftermath of Financial
Crises’
• Reinhart and Rogoff anatomy of aftermath
of financial crises in industrialised and
emerging economies
• Headlines:
– “...asset market collapses are deep and
prolonged....”
– “...profound declines in output and
employment...”
– “...real value of government debt tends to
explode...”
Asset Market Collapses
• Real estate / housing
– Average peak to trough decline of 35.5%
– Average decline duration of 6 years
– Extremes: declines of 50-60% (Finland,
Philippines, Colombia, Hong Kong); duration, 17
years (Japan)
• Equity markets
– Average peak to trough decline of 55.9%
– Average decline duration of 3.4 years
– Extremes: decline of 90% (Iceland); duration, 5
years (Malaysia, Thailand, Spain)
Unemployment and Output
• Unemployment
– Average increase of 7 percentage points over
4.8 years
– Extremes: 20 percentage points (US);
duration, 12 years (Japan)
• Output
– Average decline, 9.3% over 1.9 years
– Extremes: 29% (US); duration, 4 years (US,
Finland, Argentina)
Real Government Debt
• Average increase in government debt 3
years after crisis (excluding current crisis)
of 86.3%
• Extremes: 280% (Finland, Colombia)
UK NET PUBLIC DEBT OVER GDP
300
REVOLUTIONARY AND
NAPOLEONIC WARS
250
SECOND
WORLD WAR
AMERICAN
REVOLUTIONAR
200
SEVEN YEARS
WAR
FIRST WORLD
WAR
150
WAR OF
AUSTRIAN
"GREAT
RECESSIO
100
GREAT
DEPRESSION
50
2012
2002
1992
1982
1972
1962
1952
1942
1932
1922
1912
1902
1892
1882
1872
1862
1852
1842
1832
1822
1812
1802
1792
1782
1772
1762
1752
1742
1732
1722
1712
1702
1692
0
WAR OF SPANISH
SUCCESSION
2014
2008
2002
1996
1990
1984
SECOND WORLD
WAR
1978
1972
FIRST WORLD WAR
1966
1960
20
1954
1948
1942
1936
1930
1924
1918
1912
1906
1900
1894
1888
1882
1876
1870
1864
1858
1852
1846
1840
1834
1828
1822
1816
1810
1804
1798
1792
US GROSS PUBLIC DEBT OVER GDP
140
120
"GREAT
RECESSION"
100
80
"SUPPLY
SIDE"
DEFICITS
60
CIVIL WAR
40
GREAT
DEPRESSION
0
Global Recession
Global Recession
• The global financial crisis has pushed all
major OECD economies into recession
• Many emerging economies have slower or
negative growth due to a collapse in
export markets
• There is uncertainty regarding the depth
and duration of recession
• There is a possibility of deflation in some
economies
Globalisation of Recession
• Transmission across borders
– Integrated capital markets
– Lower capital flows
– Banking failures
– Fall in export demand
– High import content of exports
Impact on World Trade
• World trade only recorded negative growth
in one year between 1950 and 2008
• World trade slowed sharply in the final
quarter of 2008
• World trade declined by 12% in 2009, due
to:
– decline in capital flows (credit crunch)
– decline in demand (recession)
– High import content of exports (globalisation)
The Future?
Key Risk Factors
• Unexpected ‘bad news’ (scale of losses /
capacity to finance debt)
• Increased protectionism
• Slow recovery
• Recession becomes deflation
• Disorderly break-up of Eurozone
Resilience Of Global Systems
• Major ‘shocks’ of last 30 years of twentieth
century:
– Oil shocks of 1973-74 and 1980-81
– Collapse of Bretton Woods system
– Debt crisis of mid 1970’s
– High (and hyper) inflation
– Collapse of the European Monetary System
– Collapse of Soviet bloc in Europe
– Asian crisis
Some Longer-term Implications
• Low and stable inflation not sufficient to avoid cycles
• Globalisation of financial system has added to risks
• Financial system can be a powerful driver of
economic fluctuations
• Regulatory frameworks need to be reformed to limit
this source of volatility
• Greater international surveillance of imbalances may
be necessary
• Economic modellers and policy-makers need to
improve understanding of feedbacks from financial
system to economic activity