Topic 17
The connection between financial
crises, and financial regulation.
Coronavirus Recession
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
1
Learning Objectives
• The Role of the Financial System.
• Describe the causes and consequences of the global Great
Depression of 1930 and the financial crisis of 2007–2009.
• Summarize the changes to financial regulation that developed in
response to the global financial crisis of 2007–2009.
• Discuss the connection between financial crises and financial
regulation.
• The onset of Coronavirus Recession 2020- present & the
government’s extraordinary response.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
2
Learning Objective
Explain what financial crises are and what causes them.
Research has shown that recessions involving financial crises
have been longer and deeper than recessions that do not
involve financial crises.
Because financial crises disrupt the flow of funds from savers
to households and firms, they cause substantial reductions in
spending.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
3
•Flow of Funds Through the Financial System
The financial system channels funds from households and firms with surplus
funds to those individuals and firms with both a shortage of funds and productive
investment opportunities
A well-functioning financial system directs funds to where they can do the most
good, promoting economic stability and growth
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
4
The Origins of Financial Crises
A financial crisis is a significant disruption in the flow of funds from
lenders to borrowers.
•Economic activity depends on the ability of households and firms to
borrow.
•A financial crisis disrupts the flow of funds from lenders to borrowers.
•A financial crisis typically leads to an economic recession as
households and firms face difficulty in borrowing money.
•In the past, most of the financial crises in the United States involved the
commercial banking system.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
5
Learning Objective
Describe the key elements of the financial
crisis that occurred during the Great
Depression.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
6
Application: The Mother of All Financial Crises:
The Great Depression
•
Federal Reserve officials viewed the stock price boom in
1928 and 1929 as excessive speculation
•
The Fed pursued an autonomous tightening monetary policy
by raising interest rates, which caused investment to decline
•
In October 1929, the stock market crashed with stock prices
fell by more than 60%, which reduced household wealth and thus
consumer spending
•
In late 1930, droughts in the Mid-West led to a sharp decline in
agricultural production and thus an increase in farm loan losses,
which subsequently led to a full-fledged bank panic
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
7
Stock Price Data During the Great Depression
Period
Source: Dow-Jones Industrial Average (DJIA). Global Financial Data.
www.globalfinancialdata.com/index_tabs.php?action=detailedinfo&id=1165
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
8
Application: The Mother of All Financial
Crises: The Great Depression
• Falling stock prices and uncertain economic
conditions worsened adverse selection and
moral hazard problems in financial markets
• As financial institutions began charging businesses
with higher interest rates to protect themselves from
credit losses, the credit spread (the difference
between the interest rate on private loans and
the interest rate on U.S. Treasury securities)
increased
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
9
Credit Spreads During the Great Depression
Difference between the interest rate on private loans and the interest rate
on U.S. Treasury securities) increased
Source: Federal Reserve Bank of St. Louis FRED database http://research.stlouisfed.org/fred2/
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
10
Application: The Mother of All Financial
Crises: The Great Depression
• The ongoing deflation led to huge decline in prices.
• The financial markets finally started to recover after
the inauguration of President Franklin D.
Roosevelt
• As bank panics in the United States also spread
to the rest of world, and the contraction of the
U.S. economy lowered its demand for foreign
goods, aggregate demand in economies
throughout the world contracted as well
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
11
The Financial Crisis of the Great
Depression
The Start of the Great Depression (1 of 2)
Several factors helped to increase the severity of the
downturn during the Great Depression:
• Stock prices plunged, thereby reducing household
wealth, making it more difficult for firms to raise
funds, and increasing uncertainty. Higher uncertainty
leads to decreases in spending.
• In 1930, Congress passed the Smoot-Hawley Tariff
Act, which led to retaliatory increases in foreign
tariffs, thereby reducing U.S. exports.
• Following legislation that restricted immigration,
population growth declined, and spending on new
houses fell.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
12
The Great Depression
Sources: Panel (a): U.S. Bureau of Economic Analysis; panel (b): Economic historians have compiled varying estimates of
unemployment in the 1930s, years during which the federal government did not collect data on unemployment. The
estimates used in the panel are from David R. Weir, “A Century of U.S. Unemployment, 1890–1990,” in Roger L. Ransom,
Richard Sutch, and Susan B. Carter (eds.), Research in Economic History, Vol. 14, Westport, CT: JAI Press, 1992, Table
D3, pp. 341–343.
Panel (a) shows that real GDP declined by 27% between 1929 and 1933, while
real consumption declined by 18% and real investment fell by 81%.
Panel (b) shows that the unemployment rate tripled from 1929 to 1930, was
above 20% in 1932 and 1933, and was still above 10% in 1939.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
13
The S&P 500, 1920–1939
Source: Robert J. Shiller, Irrational Exuberance, Princeton, NJ: Princeton University Press, 2005, as updated at
www.econ.yale.edu/~shiller/data.htm.
The Federal Reserve raised interest rates after it became
concerned by the rapid increases in stock prices during 1928 and
1929.
The decline in stock prices from 1929 to 1932 was the largest in
U.S. history.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
14
The Bank Panics of the Early 1930s
Bank Suspensions, 1920–1939
Source: Board of Governors of the Federal Reserve System, Banking and Monetary Statistics of the
United States, 1914–1941, Washington, DC: U.S. Government Printing Office, November 1943.
Bank suspensions soared during the bank panics of the early 1930s
before falling to low levels following the establishment of the FDIC in
1934.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
15
**The Start of the Great Depression (2 of 2)
Debt-deflation process is a cycle of falling asset
prices and falling prices of goods and services that
can increase the severity of an economic downturn.
As the economic downturn worsened, the price
level would fall with two negative effects:
•Real interest rates would rise, and the real value of
debts would increase.
•This process of falling asset prices, falling prices
of goods and services, and increasing
bankruptcies and defaults can increase the
severity of an economic downturn.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
16
*The Failure of Federal Reserve Policy
during the Great Depression (1 of 2)
Why did the Fed not intervene to stabilize the
banking system?
1. No one was in charge.
Power within the Federal Reserve System was
divided. The Fed had less independence from the
executive branch, and important decisions required
forming a consensus which was hard to come by.
2. The Fed was reluctant to rescue insolvent
banks.
Fed officials believed that taking actions to save them
might encourage risky behavior (moral hazard) by
bank managers.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
17
The Failure of Federal Reserve Policy
during the Great Depression (2 of 2)
3. The
Fed failed to understand the difference
between nominal and real interest rates.
With the price level falling, real interest rates were
much higher in the early 1930s than policymakers at
the Fed believed them to be.
4. The Fed wanted to “purge speculative excess.”
Many Fed members believed that the Depression was
the result of financial speculation, so the Fed
followed the “liquidationist” policy: allowing the price
level to fall and weak banks and weak firms to fail
before a recovery could begin.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
18
Did the Failure of the Bank of United States
Cause the Great Depression?
•
In the early 1960s, Milton Friedman and Anna Schwartz wrote
about the importance of bank panics in their book A Monetary History
of the United States, 1867–1960.
•
They singled out the failure in December 1930 of the Bank of United
States, which was the largest bank to have failed in the United States
up to that time.
•
Economists continue to disagree as to whether the Federal Reserve
should have moved more forcefully to keep the bank from closing.
• Some economists argue that this episode was important
in leading the Fed to develop the “too-big-to-fail”
doctrine: no large financial institution can be allowed to fail
because its failure may destabilize the financial system.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
19
Learning Objective
Describe what caused the financial
crisis of 2007–2009.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
20
The Global Financial Crisis of 2007–
2009 (1 of 8)
• Causes of the 2007–2009 Financial Crisis:
– Financial innovations emerge in the mortgage
markets
§ Subprime mortgage
§ Mortgage-backed securities
§ Collateralized debt obligations (CDOs)
– Housing price bubble forms
§ Increase in liquidity from cash flows surging to
the United States
§ Development of subprime mortgage market
fueled housing demand and housing prices
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
21
The Global Financial Crisis of 2007–
2009 (2 of 8)
• Causes (cont’d):
– Agency problems arise
§ “Originate-to-distribute” model is subject to
principal-(investor) agent (mortgage broker)
problem
§ Borrowers had little incentive to disclose
information about their ability to pay
§ Commercial and investment banks (as well as
rating agencies) had weak incentives to
assess the quality of securities
– Information problems surface
– Housing price bubble bursts
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
22
Housing Prices and the Financial Crisis of 2007–
2009
Source: Case-Shiller U.S. National Composite House Price Index from Federal Reserve Bank of
St. Louis FRED database: http://research.stlouisfed.org/fred2/.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
23
The Global Financial Crisis of 2007–2009 (3 of 8)
• Effects of the 2007–2009 Financial Crisis
– After a sustained boom, housing prices
began a long decline beginning in 2006.
– The decline in housing prices contributed to a
rise in defaults on mortgages and a deterioration
in the balance sheet of financial institutions.
– This development in turn caused a run on the
shadow banking system.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
24
The Global Financial Crisis of 2007–
2009 (4 of 8)
• Crisis spreads globally
– Sign of the globalization of financial markets
– TED spread (3 months interest rate on Eurodollar
minus 3 months Treasury bills interest rate) increased
from 40 basis points to almost 240 in August 2007.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
25
The Global Financial Crisis of 2007–
2009 (5 of 8)
• Deterioration of financial institutions’ balance
sheets:
– Write downs
– Sell of assets and credit restriction
• High-profile firms fail
– Bear Stearns (March 2008)
– Fannie Mae and Freddie Mac (July 2008)
– Lehman Brothers, Merrill Lynch, AIG, Reserve
Primary Fund (mutual fund), and Washington
Mutual (September 2008)
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
26
The Global Financial Crisis of 2007–
2009 (6 of 8)
• Bailout package debated
– House of Representatives voted down the
$700 billion bailout package on September
29, 2008.
– It passed on October 3, 2008.
– Congress approved a $787 billion economic
stimulus plan on February 13, 2009.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
27
The Global Financial Crisis of 2007–
2009 (7 of 8)
• Height of the 2007–2009 Financial Crisis
– The stock market crash gathered pace in the
fall of 2008, with the week beginning October 6,
2008, showing the worst weekly decline in U.S.
history.
– The unemployment rate shot up, going over the
10% level in late 2009 in the midst of the “Great
Recession, the worst economic contraction in the
United States since World War II.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
28
Stock Prices and the Financial Crisis of 2007–
2009
Source: Dow-Jones Industrial Average (DJIA). Global Financial Data:
http://www.globalfinancialdata.com/index_tabs.php?action=detailedinfo&id=1165.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
29
**The Financial Crisis of 2007–2009
The Housing Bubble Bursts
• Between January 2000 and May 2006, house
prices more than doubled, while rents increased
by less than 25%, providing evidence of a
bubble.
•
Home prices began to decline in 2006 after some
homebuyers had trouble making mortgage payments.
•
When lenders foreclosed on some of these loans, they sold
the homes, causing housing prices to decline further.
•
A credit crunch occurred as most banks tightened their
requirements for borrowers.
•
Home prices dropped further as potential homebuyers had
trouble obtaining mortgages.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
30
Housing Prices and Housing Rents, 1987-2016
Sources: Federal Reserve Bank of St. Louis; and S&P/Case-Shiller, standard and poors.com.
Except for the housing bubble period, housing prices increase at about the
same rate as housing rents. Between January 2000 and May 2006, house
prices more than doubled, while rents increased by less than 25%, providing
evidence of a bubble.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
31
Bubbles, Bubbles, Everywhere! (Or Not)
• In 2016, some economists and policymakers
worried that keeping interest rates low for so long
had caused distortions to the financial system.
• In particular, some economists and policymakers
worried that the markets of financial and other assets
might be experiencing bubbles.
• Many economists believe Bubbles are much easier to
identify after the fact than before they have bust.
• Financial crises are also difficult to predict because
they happen infrequently.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
32
Policy Response to Asset-Price
Bubbles
• Types of Asset-Price Bubbles
1. Credit-driven bubbles
– A credit boom drives up asset prices, which in
turn further fuels the credit boom, driving
asset prices higher
2. Optimistic expectations-driven bubbles
– Bubbles driven solely by overly optimistic
expectations (or “irrational exuberance” )
pose less risk to the financial system than
credit-driven bubbles
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
33
*Inside the Fed: Was the Fed to Blame for
the Housing Price Bubble?
• Federal Reserve Chairman Ben Bernanke countered
this argument saying the culprits were:
§ The proliferation of new mortgage products
that lowered mortgage payments,
§ The relaxation of lending standards that
brought more buyers into the housing market,
and
§ The capital inflows from emerging market
countries.
• The debate over whether monetary policy was to blame
for the housing price bubble continues to this day.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
34
Aggressive Federal Reserve Actions
• During the 2007-2009 financial crisis, the Fed
undertook 3 types of policy actions:
1. Conventional monetary policy
–
The Fed pursued autonomous easing of monetary policy by
aggressively lowering the federal funds rate to a target range
of 0 to 0.25% by December 2008
2. Nonconventional monetary policy
–
Nonconventional monetary policy involves non-interest-rate
tools that bypass the zero-lower-bound problem of nominal
interest rates
3. Liquidity provision
–
The Fed increased its lending facilities to provide liquidity to
the financial markets through the discount window, a term
auction facility, and new lending programs
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
35
Policy and Practice: The Federal Reserveʼs Nonconventional
Monetary Policies and Quantitative Easing During the Global
Financial Crisis
• After the Fed cut its federal funds rate target to a range of 0 and
0.25%, its interest rate channel was closed
•
To stimulate aggregate demand, the Fed implemented
unconventional monetary policies:
1. Liquidity provision: Discount window expansion, term auction
facility, and new lending programs to financial institutions
2. Asset purchases (quantitative easing): QE1 in 2008, QE2
beginning November 2010, and QE3 beginning September
2012
3. Management of expectations: Fed commitment to keep the
federal funds rate at zero for a long time
•
Liquidity provision and asset purchases led to sharp increases
in the Fedʼs balance sheet
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
36
Expansion of the Federal Reserveʼs Balance
Sheet During and After the Global Financial
Crisis
Source: Federal Reserve Bank of Cleveland. www.clevelandfed.org/research/data/redit_easing/index.cfm
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
37
Aggressive Fiscal Policy
• In 2008, Congress passed the Bushʼs Economic
Stimulus Act that gave one-time tax rebates of $78
billion
• In 2009, Congress passed the Obamaʼs American
Recovery and Reinvestment Act, involving a $787
billion fiscal stimulus package with tax cuts and
government spending increases
• Both legislations aimed at raising aggregate
demand
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
38
*The Federal Government’s
Extraordinary Response to the Financial
Crisis
•
In 2008, the Fed and the Treasury unveiled a plan for
Congress to authorize $700 billion used to purchase
mortgages and mortgage-backed securities from financial
firms and other investors.
•
They used Troubled Asset Relief Program (TARP) funds
to make direct preferred stock purchases in banks to
increase bank capital.
•
In early 2009, the Treasury administered a stress test to
19 large financial firms in order to reassure investors that
the firms had sufficient capital to deal with a severe
economic downturn.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
39
Worldwide Government Intervention
Through Bailouts
• The U.S. government took an active role in providing
liquidity to the financial system during the 20072009 financial crisis through the passage of the
Economic Recovery Act of 2008:
– Created the Treasury Asset Relief Plan (TARP) that
purchased subprime mortgage assets from troubled
financial institutions
– Raised the federal deposit insurance limit temporarily from
$100,000 to $250,000
• There was also unprecedented coordination among
countries in bailing out financial institutions
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
40
Worldwide Government Bailouts During the 2007-2009
Financial Crisis
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
41
Learning Objective
Discuss the connection between financial crises and
financial regulation.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
42
Financial Crises and Financial Regulation
•
New government financial regulations typically occur in
response to a crisis. There is a regular pattern: (1) crisis,
(2) regulation, (3) response to new regulations by
financial firms, and (4) response by regulators.
Lender of Last Resort
•
•
•
Congress created the Federal Reserve System as the lender
of last resort to provide liquidity to banks during bank panics.
The Fed failed its first crucial test when it stood by while the
banking system collapsed in the early 1930s.
Congress responded to this failure by establishing the
FDIC and by reorganizing the Fed to make the Federal
Open Market Committee (FOMC) to centralize decision
making.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
43
Success in the Postwar Years and the Development
of the “Too-Big-to-Fail” Policy
•
In 1984, the comptroller of the currency provided Congress
with a list of banks that were considered “too big to fail.”
– A failure by any of these banks might pose systemic risk
to the financial system.
Too-big-to-fail policy is a policy under which the federal
government does not allow large financial firms to fail, for
fear of damaging the financial system.
During the stock market crash of October 19, 1987, Fed
Chairman Alan Greenspan announced the Fed’s readiness
to provide liquidity to support the economic and financial
systems.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
44
Success in the Postwar Years and the
Development of the “Too-Big-to-Fail” Policy
•
In 1991, Congress passed the Federal Deposit Insurance
Corporation Improvement Act of 1991 (FDICIA):
– The act required the FDIC to deal with failed banks using
the method that would be least costly to the taxpayer
(e.g., closing the bank and reimbursing the bank’s
insured depositors).
•
The act contained an exception for cases in which a bank’s
failure would cause “serious adverse effects on
economic conditions or financial stability.”
•
During the financial crisis of 2007–2009, this exception
proved to be important.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
45
The Financial Crisis and a Broader Fed Role
as Lender of Last Resort
•
•
•
•
In March 2008, the Fed and the Treasury intervened to
keep Bear Stearns from failing.
Some economists and policymakers argued that it increased
moral hazard in the financial system. This criticism may
have played a role in the Fed’s decision not to attempt to
save Lehman Brothers in September 2008.
A few days later, the Fed made a large loan to the
American International Group (AIG) insurance company
in exchange for 80% ownership of the firm.
The too-big-to-fail policy appeared to be back: the Fed,
FDIC, and the Treasury had taken actions that resulted in no
large financial firms failing with losses to investors (except
Lehman Brothers).
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
46
Will Dodd-Frank Tie the Fed’s Hands in the
Next Financial Crisis
•
As part of the 2010 Dodd-Frank Act, Congress rewrote that section
of the 1913 Federal Reserve Act and barred the Fed from making
loans ‘for the purpose of assisting a single and specific company
avoid bankruptcy.”
•
So the loans that the Fed had made to JPMorgan Chase and AIG
during the financial crisis of 2007-2009 were no longer permitted.
•
In addition, any new programs beyond lending to commercial banks
would require approval of the secretary of the Treasury.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
47
The 2010 Financial Overhaul: The End of the
Too-Big-to-Fail Policy?
•
Congress intended to end the too-big-to-fail policy by
passing the Wall Street Reform and Consumer Protection
Act (the Dodd-Frank Act) in 2010.
•
The act allows the Fed, FDIC, and Treasury to seize and
“wind down” large financial firms. Previously, only the
FDIC had this power, and it could only use it to close
commercial banks.
•
According to the FDIC, the act would lead investors to shift
funds toward smaller firms that have lower information costs of
determining the riskiness of investments.
– Larger firms would have to provide investors with higher
expected returns to compensate them for the absence of
any bailout.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
48
Lender of Last Resort: Crisis, Regulation,
Financial System Response, and
Regulatory Response
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
49
Capital Requirements: Crisis, Regulation, Financial
System Response, and Regulatory Response
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
50
The Financial Crisis of 2007-2009: Crisis, Regulation,
Financial System Response, and Regulatory
Response
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
51
The 2007–2009 Financial Crisis and the Pattern of
Crisis and Response
Key Provisions of the Dodd-Frank Act:
•
Created the Consumer Financial Protection Bureau to protect consumers in
their borrowing and investing activities.
•
Established the Financial Stability Oversight Council, to identify and act on
systemic risks to the financial system.
•
Ended the too-big-to-fail policy for large financial firms.
•
Required certain derivatives to be traded on exchanges, not over the counter.
•
Implemented the “Volcker Rule” by banning most proprietary trading at
commercial banks. (“Volcker Rule”: Prohibits banking entities from engaging in
proprietary trading or investing in or sponsoring hedge funds or private equity
funds).
•
Required hedge funds and private equity firms to register with the SEC.
•
Required that firms selling mortgage-backed securities and similar assets
retain at least 5% of the credit risk.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
52
Global Pandemic - COVID-19 Crisis
Recommended not required
Fastest Economic Contraction on
Record
V-Shape, U-Shape, W-Shape, L-Shape
Or K-Shape Recovery
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
53
•
The Onset of Coronavirus Recession 2020The Federal Government’s Extraordinary
Response
The World Health Organization declared a global pandemic
as COVID-19, popularly known as the novel coronavirus,
spreads rapidly across the world. Governments around the
world are employed a wide range of policy tools to lift their
economies as the coronavirus impacts adversely supply
and demand.
Coronavirus Recession 2020- will be considered the most
severe recession since the Great Depression of the 1930s.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
54
The global economic recession outlook
during the Covid-19 Pandemic Crisis
We will review the global economic recession outlook during the Covid-19
Pandemic Crisis, where the course of pandemic itself was by far the
most important factor. Because this recession is unprecedented in so
many ways, forecasting the recovery is difficult.
It inflicted huge damage on economies around the world.
The question was: What will be the long term impact on the global
economy, and what changes could be made as a result?
We will cover studies and forecasts that addressed both the immediate and
near-term outlook. Many studies’ forecasts envisioned around five to
seven percent contraction in global GDP in 2020.
This was the deepest global recession in decades, despite the
extraordinary steps taken by most governments to counter the
downturn with massive fiscal and monetary support
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
Topic 17
55
The global economic recession outlook
during the Covid-19 Pandemic Crisis
We believe, that over the longer horizon, the deep recessions
triggered by the pandemic are expected to leave lasting scars
through:
• On the domestic side, long-term damage to potential
output, particularly through loss of small businesses,
productivity growth, lower investment, an erosion of human
capital through lost work and schooling.
• On the global side, fragmentation of global trade and
supply chain and linkages.
It inflicted huge damage on economies around the world. More than
ever, global coordination and cooperation on many levels and
measures were required to slow the spread of the pandemic. .
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The end of Normal Monetary Policy?!
•
The Federal Reserve was among the first major central
banks to slash its benchmark rate and ease lending
conditions when the virus began to spread outside of
China.
•
The interest rate was dropped to near zero for the first time
since 2008 after two emergency rate cuts, encouraging banks to
borrow and add fresh capital to the financial system. Also launched a
massive $700 billion quantitative easing program in
government and mortgage-related bonds as part of a wideranging emergency action to protect and shelter the
economy from the impact of the coronavirus outbreak
•
Normal monetary policy once again seemed becoming far
off. The question was: Should we be once again be concerned that
the persistence of unconventional policies might have introduced
distortions that could lead to future economic instability?
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V-shaped recession, rather than the Ushaped!?
The global economy was officially in a recession
almost 11 years after the most recent one as the Covid19 pandemic continues to shutter businesses and keep
people at home.
§ Some economists expected to see a V-shaped
recession, rather than the U-shaped one seen
during the 2008 financial crisis. In other words, the
pain was expected to be much deeper, but shorter, if
some of these experts were right. Yet others saw a W
or K-shaped recession.
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*But even after the virus is tamed --and no
one really knows when that will be…..
•
The world that emerges is likely to be choked with trouble,
challenging the recovery. Mass joblessness exacts societal costs.
Widespread bankruptcy could leave industry in a weakened state,
depleted of investment and innovation.
•
“The psychology won’t just bounce back,” said Charles
Dumas, chief economist at TS Lombard, an investment
research firm in London. “People have had a real shock. The
recovery will be slow, and certain behavior patterns are
going to change, if not forever at least for a long while.”
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A coronavirus-induced recession could last
through 2021, according to Morgan Stanley CEO
James Gorman.
"I think, you know, through the end of next year we're
going to be working through this global recession,"
Gorman told CNBC in an interview.
Gorman asserts that while he wishes and hopes for a V-shaped
recovery, he does not expect one. "You can't have this kind of
dislocation and expect people to bounce immediately," he said, adding
that "this is not going to turn on a dime.”
The best-case scenario is a U-shaped recovery,
Gorman said. "If I were a betting man, it's
somewhere between a U and I guess an L," he
said, adding that it's likely that reopening the
economy will take months.
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Paul Krugman
•
“The
economic contraction we’re experiencing is
the fastest on record, by a large margin; we’ve probably
lost as many jobs over the past two weeks as we did in the
whole of the Great Recession. The policy response is also
gigantic, several times as large a share of gross domestic
product as the Obama stimulus”.
•
The main moral of this analysis is that what we should be
doing — and to some extent what we are doing — is more
like disaster relief than normal fiscal stimulus, although
there’s a stimulus element too. This relief can and should
be debt-financed. There may be a slight hangover from
this borrowing, but it shouldn’t pose any major problems.”
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Paul Krugman
• How do we pay for relief?
•
•
•
•
“Where will the government get the money for the $2 trillion bill
that Congress has already passed, a bill that’s much better
than nothing but still far short of what we should be doing?
The answer is, borrow. Real interest rates on federal borrowing
are negative; the markets are basically begging the feds to take
their money.
But why is borrowing so cheap? Where’s the money coming
from? The answer is private savings that have nowhere else to go.
“When we finally get data on what’s happening now, we’ll surely see
a sharp rise in private saving, as people stop buying what they can’t,
and a fall in private investment, because who’s going to build
houses or office parks in a plague?”
So the private sector is going to be running a huge financial
surplus that’s available for government borrowing. And this is
no time to worry, even slightly, about the level of government
debt.”
FBE 424 – Financial Institutions and Capital Markets
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Paul Krugman
Still, the pandemic will eventually end. Will there be a debt
hangover?
• From the point of view of government solvency, none at all.
We live in a world in which interest rates are consistently
below the growth rate, so that government debt melts instead
of snowballing. The government won’t have to pay back the
money it’s borrowing, just return to a sustainable level of
deficits (not zero) and let the debt/GDP ratio decline over time.
•
There might, however, be a slight macroeconomic issue when
the pandemic ends. The private sector will have added
several trillion dollars to its wealth via more or less forced
saving; between that wealth increase and, perhaps, pent-up
demand, there might — might — be some inflationary
overheating when things return to something like normal.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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Paul Krugman
•
“This may be a nonissue in an era of secular stagnation,
when we might welcome the extra demand. Even if it is an
issue, however, it’s unlikely, given the numbers, to be
something the Fed can’t contain with modestly higher
interest rates. You could imagine a world in which the costs
of the immediate crisis eventually require some future fiscal
austerity, but I don’t think we’re living in that world.”
•
Let me summarize where we are. We’re facing a period
of unknown length when much of the economy can and
should be shut down. The principal goal of policy
during this period should not be to boost GDP but to
alleviate the hardship facing those deprived of their
normal incomes. And the government can simply
borrow the money it needs to do that.”
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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Understanding the Economic Shock of Coronavirus
by Philipp Carlsson-Szlezak, Martin Reeves and Paul Swartz
Harvard Business Review March 27, 2020 (1 of 10)
“Financial system risks. The unprecedented Covid-19
shock has already generated stress in capital markets,
triggering a forceful response from central banks. If
liquidity problems persist and real economy problems lead
to write-downs, capital problems can arise.
While from a policy perspective we may know the
solutions, bailouts and recapitalization of banks are
politically controversial. In the case of a financial crisis,
capital formation would take a huge hit, driving a
prolonged slump with damage to labor and productivity
as well.”
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©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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Understanding the Economic Shock of
Coronavirus (2 of 10)
• Extended real economy “freeze”- The truly
unprecedented possibility.
•
Months of social distancing could disrupt capital formation and
ultimately labor participation and productivity growth. Unlike financial
crises, an extended freeze of this magnitude damaging the supply
side would be new territory for policy makers.
•
The financial and real economy risks are interrelated in two ways:
First, a prolonged Covid-19 crisis could drive up the number of real
economy bankruptcies, which makes it even harder for the financial
system to manage. Meanwhile, a financial crisis would starve the real
economy of credit.
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Understanding the Economic Shock of Coronavirus(3 of 10)
• V-Shape. “In 2008, Canada avoided a banking crisis: Credit
continued to flow, and capital formation was not as significantly
disrupted. Avoiding a deeper collapse helped keep labor in place and
prevented skill atrophy. GDP dropped but substantially climbed back
to its pre-crisis path. This is typical of a classic “V-shape” shock,
where output is displaced but growth eventually rebounds
to its old path.
• U-Shape. The United States had a markedly different path.
Growth dropped precipitously and never rebounded to its pre-crisis
path. Note that the growth rate recovered (the slopes are the same),
but the gap between the old and new path remains large,
representing a damage to the economy’s supply side, and indefinitely
lost output. This was driven by a deep banking crisis that
disrupted credit intermediation. As the recession dragged on, it
did more damage to the labor supply and productivity. The U.S.
in 2008 is a classic “U-shape” — a much more costly version
than Canada’s V-shape.
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*Understanding the Economic Shock of
Coronavirus (4 of 10)
• L-shape. Greece is the third example and by far the worst
shape — not only has the country never recovered its prior
output path, but also its growth rate has declined. The distance
between old and new path is widening, with lost output continuously
growing. This means the crisis has left lasting structural damage
to the economy’s supply side. Capital inputs, labor inputs, and
productivity are repeatedly damaged. Greece can be seen as an
example of L-shape, by far the most pernicious shape.
•
So, what drives “shock geometry” as shown above? The key
determinant is the shock’s ability to damage an economy’s supply
side, and more specifically, capital formation. When credit
intermediation is disrupted and the capital stock doesn’t grow,
recovery is slow, workers exit the workforce, skills are lost,
productivity is down. The shock becomes structural.”
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Understanding the Economic Shock of
Coronavirus (5 of 10)
V, U, L shocks can come in different intensities. A
V- shaped path may be shallow or deep. A U-shape may
come with a deep drop to a new growth path or a small
one.
Where does the coronavirus shock fit in so far?
The intensity of the shock will be determined by the
underlying virus properties, policy responses, as well as
consumer and corporate behavior in the face of adversity.
But the shape of the shock is determined by the virus’
capacity to damage economies’ supply side, particularly
capital formation. At this point, both a deep V-shape and a
U are plausible. The battle ahead is to prevent a clear U
trajectory.
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Understanding the Economic Shock of
Coronavirus (6 of 10)
• Keeping the geometries above in mind, this leads to two
questions about the Covid-19 shock:
What is the mechanism for damage to the supply side?
What is the policy response to prevent such damage?
•
Classically, financial crises cripple an economy’s supply
side. There is a long history of such crisis, and policy makers have
learned much about dealing with them.
• But coronavirus extends liquidity and capital problems
to the real economy — and does so at unprecedented
scale.
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Understanding the Economic Shock of
Coronavirus (7 of 10)
Let’s look in more detail at the two paths for Covid-19 to
deliver structural damage in a U-shaped scenario:
It is important to recognize that none of the shock scenarios
outlined above will be inevitable, linear, or uniform across
geographies.
Countries will have considerably different experiences for two
reasons: the structural resilience of economies to absorb such
shocks — call it destiny — and the capacity of medical
researchers and policy makers to respond in new ways to an
unprecedented challenge — call it innovation. Can they create
novel interventions, at unprecedented speed, that will break the
intractable and unattractive tradeoff between lost lives and creating
economic misery?
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Understanding the Economic Shock of
Coronavirus (8 of 10)
• On the medical side: It’s clear that a vaccine would reduce the
need for social distancing and thus relax the policy’s chokehold on
the global economy. But timelines are likely long, and so the focus
may well have to be on incremental innovation within the confines
of existing solutions.
•
•
Examples of such innovation may be found across the entire
medical spectrum: on the therapeutic end, existing treatments may
prove effective in fighting the disease. Several dozen existing
treatments are currently being evaluated.
On the other end of the spectrum, organizational innovation will
be needed to free up capacity to meet the demand for resources,
such as the optimal mobilization of medical professionals,
repurposing of spaces for treatment, and changes to triaging medical
care to prioritize the Covid-19 crisis.
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*Understanding the Economic Shock of
Coronavirus (9 of 10)
• “On the economic side: In the U.S., politicians
have passed over a $2 trillion stimulus package to
soften the blow of the coronavirus crisis.
• But policy innovation also will have to occur. For
example, central banks operate so-called
“discount windows” that provide unlimited shortterm finance to ensure liquidity problems don’t
break the banking system. What is needed now,
today, is a “real economy discount window” that
can also deliver unlimited liquidity to sound
households and firms.
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Understanding the Economic Shock of
Coronavirus (10 of 10)
The emerging policy landscape includes many
worthwhile ideas. “bridge loans” that offer zerointerest loans to households and firms for the duration of the
crisis and a generous repayment period; a moratorium on
mortgage payments for residential and commercial
borrowers; or using bank regulators to lean on banks to
provide finance and to rework terms on existing loans.
We think there is a chance for innovation to prevent a
full-blown U-shape, keeping the shock’s path closer to a
deep V-shape than would otherwise be possible. But the
battle is underway, and without innovation the odds are not
in favor of the less damaging V-shaped scenario”.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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Joseph Stiglitz
Nobel Prize-winning economist Joseph Stiglitz is ripping
the Trump administration's response to the coronavirus
pandemic, cautioning that the U.S. could be headed toward
a second Great Depression as a result.
“The numbers turning to food banks are just enormous and
beyond the capacity of them to supply," Stiglitz told The
Guardian in an interview. "It is like a third-world
country. The public social safety net is not
working.”
"The inequality in the U.S. is so large. This
disease has targeted those with the poorest
health. In the advanced world, the US is one of
the countries with the poorest health overall and
the greatest health inequality.”
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The Conference Board Economic
Forecast for the U.S. Economy- April 9,
2020
The US economy will contract between 3.6 and 7.4 percent
in 2020
Given the highly volatile nature of the ongoing COVID-19
Pandemic, The Conference Board continues to rely upon a
scenario- based approach to its US economic forecasting.
To help businesses navigate and consider how to respond to a
variety of environments that may emerge over the coming
months, The Conference Board has developed four scenarios
for the course of the US economy for the remainder of 2020.
FBE 424 – Financial Institutions and Capital Markets
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The Conference Board Economic Forecast for the
U.S. Economy- April 9, 2020
The Conference Board has developed four scenarios for the
course of the US economy for the remainder of 2020:
May Reboot (quick recovery): Assumes a peak in new
COVID-19 cases for the US as a whole by mid-April. Economic
activity may gradually resume in May beginning with the most
impacted sectors, such as restaurants, travel, etc. Even in this
optimistic scenario, annual GDP growth contracts by 3.6 percent.
Summertime V-Shape (deep contraction, V-shaped
recovery): Assumes that the peak in new COVID-19 cases will
take place in early May, creating a deep economic contraction
in Q2, especially for consumption. While we may see a strong
recovery in Q3, annual GDP growth will still contract by as much
as 6.6 percent.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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Understanding the Economic Shock of
Coronavirus
FBE 424 – Financial Institutions and Capital Markets
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*The
Conference Board Economic Forecast for the
U.S. Economy- April 9, 2020
Fall COVID-19 Resurgence (2nd contraction in Q4, Wshaped recovery): Attempts to keep new COVID-19 cases
under control in the Fall fail, requiring the implementation of
stringent measures starting in October. The economy would
begin to contract again in Q3, following a recovery in Q4.
Annual GDP growth contracts to 7.4 percent – substantially
more than under the previous scenarios.
Fall Recovery (extended contraction, U-shape recovery):
Government policies such as social distancing help to ‘flatten the
curve’ but extend economic weakness to Q3. The recovery will
be slower but more controlled than in the V- and W-shaped
scenarios, giving businesses more time to prepare for the
recovery.
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The Conference Board Economic Forecast for the U.S.
Economy- April 9, 2020
While we refrain from attaching probabilities to the scenarios, creating any
false sense of certainty, at present we treat the Fall Recovery
scenarios as our base case.
Under this scenario, we assume that social distancing measures are executed in a
balanced fashion that prioritize protecting people’s health and wellbeing while
simultaneously gradually rebooting the economy. On the basis of this scenario
we forecast a 33 percent contraction in GDP in Q2 (on an annualized basis)
and no growth in Q3. While Q4 will see a sizable rebound, the economy
will contract by 6.5 percent for the entire year (compared to 2019).
A significant reduction in consumer spending is the
primary driver of this weakness, but weak residential and
non-residential investment, exports, and a reduction in inventories
exacerbate the pain. Unemployment would rise to 15 percent by May, and
average 12% in both Q2 and Q3, and then gradually drop off to 8 percent by Q4.
Fiscal stimulus from the government would be insufficient to offset
weakness in the private sector of the economy.
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©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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K- Shaped Economic Recovery: Divergent
experiences
A K-shaped recovery occurs when, following a recession, different parts of the economy recover at different
rates, times, or magnitudes. ... This type of recovery is called K-shaped because the path of different parts of the
economy when charted together may diverge, resembling the two arms of the Roman letter "K."
The Pandemic has sent some businesses booming and many others
not. For some it’s been sharp rebound for others it’s a continuing
decline. The Amazons, the Googles and the Facebooks of the world
felt very little impact- their impact smaller and likely to rebound more
quickly.
Skilled workers are able to work from home in many cases, continue
seamlessly with their jobs and potentially avoiding exposure to the
virus.
A "K-shaped" recovery is one where the wealthiest recover while lowerincome Americans see their economic situation continue to decline- divergent
outcomes for different types of industries and workers.
The wealthiest Americans are quickly rebounding, even thriving, while the
middle- and lower-income set are not."
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What is the K-Shaped Recovery?
Suzanne Clark :President, U.S. Chamber of Commerce 2021
On the positive side, we’ll continue to see tech companies and
some segments of the retail industry, for example, thrive as their
products or services directly support work, education, health, or
simply daily life in a pandemic.
Their ability to operate, adapt, and expand in this environment
has kept people healthy, connected, and productive.
They are supporting remote work, learning, and telemedicine and
ensuring food, supplies, and medicine continue to flow into our
homes. Their success has also kept the stock market hovering
around all-time highs and is expected to drive the strongest
growth rate on record in the third quarter. That's the top arm
of a K-shaped economic recovery.
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©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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What is the K-Shaped Recovery?
Suzanne Clark : President, U.S. Chamber of Commerce 2021
• Yet, the other side of the recovery is bleak. For countless
companies in the travel, entertainment, leisure, hospitality, and
food service industries, there is no end in sight to the economic
malaise.
•
As long as necessary social distancing and public health
restrictions are in place , it will be difficult if not impossible to get
back to strength. Though many are diligently working, innovating,
and adapting to stay open, there is only so long they can survive
on razor thin margins with persistently diminished revenue.
•
The uneven recovery is even cutting across some sectors, which
explains why some retailers are setting records while others are facing
liquidation. Small businesses across industries are facing similar
challenges.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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What is the K-Shaped Recovery?
Suzanne Clark -President, U.S. Chamber of Commerce 2021
• The K-shaped recovery is also evident in employment numbers.
•
The financial services sector, for example, has already recovered
94% of its pre-pandemic employment.
• Leisure and entertainment, on the other hand, has only brought
back 74% of the workforce.
• So, while many of us are lucky to mainly be Zoom-fatigued or otherwise
distressed by life in a pandemic, for millions of others, the economic
impact of COVID is existential.
• The layoffs have come hardest and fastest for those least able
to survive prolonged joblessness, creating a cascade of
setbacks from which it will be very hard to recover.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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World Economic Outlook
Global economy on firmer ground, but with
divergent recoveries amid high uncertainty
IMF April 2021
Global prospects remain highly uncertain one year into pandemic.
New virus mutations and accumulating human toll raise concerns,
even as growing vaccine coverage lifts sentiments. Recoveries are
diverging across countries and sectors, reflecting variations in
pandemic induced disruptions and the extent of policy support.
The outlook depends not just on the outcome of the battle between
the virus and vaccinations, but also on how effectively economic
policies deployed under uncertainty can limit lasting damages from
this unprecedented crisis.
FBE 424 – Financial Institutions and Capital Markets
©2022 Fatemeh Ibrahimi Nazarian and Pearson Higher Education
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World Economic Outlook
•
Global growth according to IMF, going from -3.3% in 2020 to projected t 6%
in 2021, moderating to 4.4% in 2022.
•
For US from -3.5% in 2020 to projected 6.4% in 2021 and 3.5% in 2022 .
For Euro Area from -6.6% in 2020 to 4.4% in 2021 and 3.8% in 2022
•
And, for Emerging markets and developing economies at 6.7% in 2021,
moderating to 5.0% in 2022. China from 2.3% in 2020 to projected 8.4% in
2021 and 5.6% in 2022. India from -8.0% in 2020 to 12.5% in 2021 and
6.9% in 2022. Mexico from -8.2% in 2020 to projected 5.0% in 2021 and
5% in 2022. Brazil -4.1% in 2020 to 3.7% in 2021 and 3.1% in 2022
•
The projections for 2021 and 2022 are stronger than in the October 2020.
High uncertainty surround this outlook, related to the path of the pandemic,
the effectiveness of policy support to provide a bridge to vaccine-powered
normalization, and the evolution of financial conditions.
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Outlook: Recoveries in Labor Market
– The labor market fallout from the Covid-19 shock continues,
with young and lower-skilled workers hard hit.
– Preexisting employment trends favoring a shift away from jobs
that are more vulnerable to automation is accelerating.
– Policy support for job retention is extremely powerful at
reducing scarring and mitigating the unequal impact from the
acute pandemic shock.
– As the pandemic subsides and the recovery normalizes, a
switch toward worker reallocation support measure could help
reduce the unemployment more quickly and ease the
adjustment to the permanent effects of the Covid shock on the
labor market.
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Outlook: Monetary Policy
•
Monetary Policy easing by advanced economies early in the
pandemic provided much financial relief including to emerging
markets. Looking ahead, a multispeed recovery from the crisis will
raise some challenges.
•
While a US tightening resulting from a stronger economy tends to be
benign, for most emerging economies a surprise tightening triggers
capital outflows from emerging markets.
•
It will therefore be important for advanced economies to explain
clearly how they will implement their monetary policies during the
recovery.
•
Emerging economies must reduce their vulnerability to adverse
financial spillovers by adapting more transparent and rule-based
monetary and fiscal frameworks,
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