Introduction to the Course
and Main Issues in the Global
Economy
by
Nouriel Roubini
Stern School of Business
New York University
September 2014
International Macroeconomic Policy:
Theory and Evidence from Recent
Financial Crises
• We study macroeconomic developments: growth,
unemployment, consumption, investment, inflation, trade
balances, exchange rates, etc.
• Macroeconomics is an international discipline as most
economies are not closed but open to trade in goods,
services, labor, capital, technology, information
(globalization).
• Most countries are small open economies; some (U.S.)
are large open economies. The world economy is
interdependent and interconnected thanks to
globalization
International Macroeconomic Policy
• Macroeconomic developments depend on macro
policies:
– Conventional (the policy rate tool, the money supply)
and unconventional monetary policy such as, ZIRP
(Zero Interest Rate Policy), QE (Quantitative Easing),
CE (credit easing), FG (Forward Guidance), Negative
Interest Rates, Liquidity Support of Banks and NonBanks
– Conventional (tax and government spending) and
unconventional fiscal policy (bailouts and backstop of
banks, households, corporations and other state
guarantees for economic agents
International Macroeconomic Policy
• Macroeconomic developments depend on macro
policies:
– Exchange rate policies: choice of the exchange rate
regime (fixed, flexible, etc.), forex intervention, capital
controls
– Supervision and regulation of the banks and other
financial sector intermediaries (capital regulation,
liquidity regulation, macro-prudential supervision,
counter-cyclical credit policy)
– International economic policies such as coordinated
macro policies as well as international bailouts (by
the IMF or the “Troika”) of countries or bail-in of
countries (coercive restructuring of public and/or
The nexus between macro news, policy
reactions and markets/asset prices
• Macro Triangle: macro developments/news, policy
reaction, markets and asset prices
• Macro developments/news lead to policy reactions
• Those policy reactions affect the evolution of the macro
variables
• Macro news and macro policies affect markets and asset
prices (stocks, bonds, currencies, commodities, credit)
• Asset prices react to macro news and policy news, ie
unexpected rather than expected changes.
• Asset price changes lead to policy reactions and affect
macro variables (through wealth effects and price
effects)
Theory and Evidence from Recent
Financial Crises
• Financial crises have become more frequent and severe
in both developed markets (DM) and emerging markets
(EM)
• Recent developed markets crises
– US housing and sub-prime crisis in 2006-2008
– Global Financial Crisis (GFC) of 2008-2009
– Sovereign debt crises and economic crisis in the Eurozone
(2010-2013): Greece, Ireland, Portugal, Spain, Italy, Cyprus,
Slovenia
• Recent emerging market crises:
– Mexico (1994), East Asia (1997-98), Russia (1998), Brazil
(1999), Turkey and Argentina (2001)
– EM mini-crisis in 2013-14
Nature of Financial Crises
• There are many types of financial crises:
– Currency crisis when a fixed exchange rate regime collapses or
a currency goes into a free fall
– Balance of Payments (BoP) or external debt crisis
– Sovereign debt crisis
– Banking crisis
– Corporate debt crisis
– Household debt crisis
– Broad financial crisis that combines many elements of the above
crises
Types of financial crises: liquidity
versus solvency crises
• Financial Crises can be distinguished into two broad
types:
– Solvency crises
– Liquidity crises
• Insolvency: An agent is insolvent when its debt relative
to its income is so high that in most states of the world it
will not be able to pay back its debt and the interest on it
(unsustainable debt)
• Illiquidity: An agent is solvent but illiquid when its debt is
not unsustainable but it has large amounts of this debt
coming to maturity (short term debt) and it is not able to
roll it over (liquidity crisis, rollover/run crisis)
Liquidity versus Solvency Crises
• Many combinations of liquidity/illiquidity and
solvency/insolvency
• Illiquidity can lead to insolvency as illiquidity can trigger
default
• Illiquidity can be resolved via:
– Domestic or international lender of last resort support
(bailouts) to stop rollover/run crises
– Orderly but coercive restructuring (maturity extension)
of debts (bail-in of creditors policies)
• Insolvency is resolved via:
– Orderly debt restructuring before default
– Disorderly debt restructuring (default)
Course Structure
• Syllabus:
http://people.stern.nyu.edu/nroubini/MACRO5.HTM
• Textbooks
• Reading List:
http://pages.stern.nyu.edu/~nroubini/Readingl3.html
• Assignments:
http://people.stern.nyu.edu/nroubini/ASSIGN01x.HTM
• Requirements (assignments, mid-term exam, final exam)
• Other online and offline tools for the course
Current Global Economic Outlook and
Uncertainties (Known Unknowns)
• Former U.S. Defense Secretary spoke during
the Iraq War of “known knowns, known
unknowns and unknown unknowns”.
• Known unknowns are known risk/uncertainty
factors that will materialize in the future in one
way or another
• The world economy is characterized today by
many “known unknowns”, for example which
party will win the 2014 U.S. midterm elections?
Known Unknowns: Brazilian
presidential elections
• Known Known: Neves is not likely to be
the next Brazilian president
• Known Unknown: Will the next Brazilian
president be Roussef or Silva?
• Unknown unknown (as of last summer):
Death or presidential candidate Campos.
Known Unknown: Economy, Fed
Tapering and exit from QE
• Will economic growth finally accelerate
above potential?
• Will wage and price inflation remain
contained or accelerate?
• When will the Fed finish tapering QE?
– October FOMC meeting
– December FOMC meeting
– In 2015
Known Unknown: Fed Forward
Guidance & Exit from Zero Policy Rate
• When will the Fed start exiting from Zero Policy Rate
(Fed Funds rate)?
– In 2014
– In first half of 2015 (Q1 or Q2?)
– In second half of 2015 or later
• When will the Fed finish normalizing the policy rate to a
neutral level and what this level will be?
–
–
–
–
One year after starting (as in the 1994-1005 cycle)
Two years after starting (as in the 2004-2006 cycle)
Three years after starting
More than three years after starting
Known Unknown: U.S. Fall Fiscal
Fistfights
• Three fiscal known unknowns in 2015 in
the U.S.:
– Government shutdown in late 2015 if
Republicans win the Senate ?
– Will Republicans start another fight on the
debt ceiling in 2015?
– Continuation of the spending sequester or
agreement to replace it with something else
post 2015?
Macro and market implications of these
known unknowns
• The resolution of these known unknowns
(growth and inflation, Fed tapering end, Fed exit
from zero rates - first hike and normalization
pace -, U.S. fiscal fights in Congress) will affect:
– The real economy through demand and
confidence (consumer, business) effects
– The financial markets and asset prices in the
U.S. and globally: bond yields, stock market,
credit spreads, U.S. credit rating, U.S. dollar
value, commodities, emerging markets.
Current Known Unknowns
in the Global Economy
• U.S. economic, monetary and fiscal
uncertainties
• Prospects for growth in developed markets (DM)
and emerging markets (EM)
• Will DM return to strong growth or will the
recovery remain anemic and sub-par?
• Is the recent slowdown in EM cyclical or
structural?
• Will some EM experience a full crisis and which
ones are at risk?
Current Known Unknowns
in the Global Economy: Europe
• Will the recovery of growth in the Eurozone be
robust or weak/anemic/uneven?
• Is the EZ at risk of deflation?
• Will the Italian government survive?
• Political risks in Greece, Portugal?
• Will the ECB start formal QE (purchase of
sovereign bonds) and when?
• Will EZ fiscal policy become more flexible?
• Will structural reforms accelerate and where?
• Will the Euro keep on weakening?
Current Known Unknowns
in the Global Economy: Japan
• Will Abenomics work in Japan?
– Strong growth and inflation increase or
relapse?
– Will structural reforms and trade liberalization
be implemented including TPP?
– Will the VAT tax be increased again in 2015
– Will the BoJ do additional QE in 2014?
– What is the risk of a public debt crisis in the
next few years?
– Will the Yen weaken further and equities
rally?
Current Known Unknowns
in the Global Economy: China
• Will China experience a soft landing or hard
landing?
• Will China successfully rebalance growth away
from too much savings, investment and exports
towards private consumption and labor intensive
growth?
• Which structural reforms will be implemented in
2015?
• Will China do another round of policy easing this
year as growth looks fragile?
• Will the RMB appreciate or not in 2015?
Current Known Unknowns
in the Global Economy: EM
• Is the recent slowdown of EM cyclical or
structural? What are its causes?
• Will financial pressures intensify to the point of a
crisis in some EM or will they diminish?
• Which EM are most at risk and why?
• What policy options are available for these EM
at risk?
• What are the medium term prospects for the
BRICS and other EM?
Current Known Unknowns
in the World: Geopolitical Risks
•
•
•
•
Will the Russia-Ukraine conflict escalate or not?
Syria-Iraq: further destabilization?
Israel/U.S. versus Iran on nuclear proliferation
Asian territorial issues (as in the case of JapanChina dispute on some islands)
• Geo-political implications of the rise of China:
“peaceful rise”?
• Which other unknown unknowns (like a 9/11
event or other terrorist attacks)?
• Will markets keep on ignoring geopolitical risks?
The global economy after the global
financial crisis (GFC)
• The economic recovery after the GFC was twospeed:
• Anemic, sub-par, below trend in DM (US, EZ,
UK, Japan): U-shaped
• Strong with return to potential or above trend in
most EM: V-shaped
• Why V-shaped in EM?
– Less balance sheet problems of too much private and
public debts. Cleanup after EM crises of the 1990s
– Higher potential growth (5% in EM vs 1-2% in DM)
– More room for policy response
Why U-shaped Recovery in DM?
• The 2008-09 crisis was not a plain vanilla recession
• It was a recession caused by a financial crisis. And a
financial crisis caused initially by too much debt and
leverage in the private sector (households, banks and
some corporates); and then during the crisis by a surge
in public debt and deficits
• History and theory suggests that recovery from balance
sheet crises is anemic for up to a decade: you need to
spend less and save more (dissave less) to reduce debt
and leverage over time. Thus, an anemic recovery.
• Actually, a double dip recession in some DM (EZ, UK,
Japan)
How did we avoid a
Great Depression 2.0?
• During the GFC (btw the collapse of Lehman
and mid-2009) global economic activity was
falling at a speed similar to the beginning of the
Great Depression
• The Great Recession of 2008-09 could have
ended up into Great Depression 2.0.
• What avoided that? Learning the lessons of the
Great Depression and avoiding policy mistakes
– Large conventional/unconventional monetary easing
– Massive fiscal stimulus for a while
– Backstop and bailout of the private sector (financial
system, households, corporations)
Side effects of the massive policy
response during the GFC
• The massive monetary/fiscal/bailout
response during the GFC was necessary
to avoid another depression
• But it has led to lingering problems:
– How to exit from ZIRP, QE, CE, FG?
– How and how fast to reduce fiscal deficits and
debts that may be unsustainable?
– How to deal with the moral hazard that
bailouts have induced?
Do you want to be Keynesian or
Austrian following a financial crisis?
• Keynesian approach: provide monetary & fiscal stimulus
and bailout the private sector as otherwise the recession
can lead to a depression as self-fulfilling panics and runs
occur while private demand is collapsing
• Austrian approach (“Austerian”): front-load the
adjustment/reform and restructure balance sheets and
P&Ls. Don’t bailout as you postpone financial and
operational restructuring and you cause moral hazard:
zombie banks, households, governments
• Austrian approach was tried in the 1930s (no
monetary/fiscal stimulus and allow banks to collapse)
and led to Great Depression. “Liquidate liquidate!”
• Bernanke learned the lessons of the Great Depression
Do you want to be Keynesian or
Austrian following a financial crisis?
• In the short run you want to be Keynesian as
you want to avoid panic, animal spirits, runs and
illiquidity to lead to a collapse of the private
sector. Public demand has to substitute for
collapsing private demand. Rescue illiquid but
solvent agents.
• In the medium-long term you want to be more
Austrian and do true economic and financial
restructuring as, otherwise, you can zombify the
economy and reduce long term growth
• Are problems of illiquidity or insolvency?
These debates – Keynesian vs
Austrian- are still ongoing today
• Growth versus austerity debate
• Front load fiscal austerity (as in EZ and
UK) or back load it (US, Japan)?
• Be very aggressive in monetary easing
(US and Japan) or less aggressive (UK,
EZ)?
• Bailout banks and recapitalize them fast
(US) or go slow (EZ, UK)?
Empirical evidence on
appropriate policy response
• US avoided a double dip recession and is
growing at a 2%+ rate (output above pre-crisis
level). Now even Japan is growing better
• UK growing more strongly after anemic recovery
• EZ had a double dip recession and is now barely
growing (output still below pre-crisis level)
• What explains this relative performance?
– Relative monetary easing stronger in US/Japan/UK
– Front load or back load of fiscal consolidation
– Backstopping the financial system and recapitalizing
the banks early on to avoid a severe credit crunch
Recent Reversal of
DM vs EM Growth Fortunes
• In 2010-2012 slow, anemic growth in DM
(U-shaped), strong growth in EM (Vshaped)
• In 2013-14:
– Signs of stronger growth in DM (US, UK,
Canada, less so in EZ and Japan)
– Sharp slowdown of growth in EM and financial
pressures on EM markets
Why growth is recovering in DM?
• Deleveraging of private and public sector
balance sheets has been ongoing for six years.
• New rounds of unconventional monetary policies
in the U.S., Japan (QE and FG) and even in the
EZ and UK ( effective QE, CE and FG)
• Bailouts of banks and sovereigns in the EZ
avoided a worse crisis and EZ break-up.
• Global tail risks are now lower
• The massive monetary stimulus has led to asset
reflation (equity, housing, lower bond yields) that
boosts confidence and increases demand
Why DM recovery will remain
uneven?
• Deleveraging not over as debt ratios
remain high
• Slow structural reforms
• Risk of a secular stagnation
• Easy monetary policies are becoming less
effective as asset reflation may run out of
steam
• Policy and regulatory uncertainties
DM outlook
• Differential in growth rates (US/UK versus
EZ/Japan)
• Inflation below 2% target in DM given still
slack in goods and labor markets
• But inflation weaker in EZ and Japan
relative to US/UK given differential growth
recovery
• Risk of asset/credit inflation/bubbles?
• Exit from zero rates will be faster in US/UK
than in EZ/Japan where QE will continue
Why slowdown of Growth in EM
and Financial Pressures?
• Strong growth in EM in the last decade (2003-2013) was
due to structural factors and cyclical/luck ones
• Structural:
– 1st generation structural reforms (trade liberalization,
openness to FDI, privatizations, opening of the
economy)
– Sounder monetary and fiscal policy and stronger
balance sheets after the EM crises of the 1990s
• Cyclical:
– China boom (10-11% growth)
– Commodity super-cycle (partly because of China)
– Super-easy monetary policies in DM after 2009. Zero rates and
wall liquidity searching for yield
Why slowdown of Growth in EM
and Financial Pressures?
• Why slowdown now then?
• 2nd generation reforms did not occur (micro ones that
increase competition and productivity)
• Move away from market oriented policies towards state
capitalism
• Some laxity in monetary and fiscal policy as liquidity was
abundant, interest rates too low and credit excesses
• End of luck as:
– China is slowing and becoming less resource oriented
– The commodity super-cycle is over
– However slowly the Fed will finish taper and exit 0%
rates. US bond yields up from 1.6% to 2.9% after May
2013 taper tantrum
Which EM will suffer the most?
• Some EM have stronger macro, financial and
policy fundamentals and some have weaker
ones
• Weaker ones include countries with large
current account deficits, large fiscal deficits,
falling growth, rising inflation, socio-political
protest and recent/upcoming elections
• Weaker group includes the Fragile Five: India,
Indonesia, Brazil, Turkey, South Africa, Ukraine
• Other fragile EM include Hungary, Russia,
Ukraine, Argentina, Venezuela, Thailand
Will some EM experience a severe
financial crisis?
• Compared to the past even the weaker EM (fragile five)
have some positives:
– Flexible exchange rates rather than fixed ones that
could collapse
– A war chest of forex reserves to avoid liquidity runs
on banks, currencies and governments
– Less currency mismatches and liability dollarization
– Lower private/public/external deficits and debts: less
solvency risk
– Better regulated banks and financial systems
Will some EM experience a severe
financial crisis?
• But the weaker EM have some negative risks
• Ugly policy dilemma:
– If you tighten monetary policy to avoid currency free
fall and inflation, you kill growth and damage
banks/corporations. So tight money is not credible.
– If you loosen monetary policy to boost growth, there is
the risk of an inflationary free fall of the currency and
risk that foreigners will not finance your external
deficit. If you thus loosen monetary policy you may
lose the nominal anchor of the economy and thus
cause a free fall
– So damned if you do and damned if you don’t.
Fragile EM in 2014-15
• Jan-Feb 2014 EM pressures: Argentina,
Turkey, Thailand politics and China scare
• Market pressure abated after February
2014 as many fragile EM tightened
monetary, credit and fiscal policy. Markets
rally this year.
• But macro and structural adjustment is still
partial and necessary in fragile EM
• Question on whether Fed exit from zero
rates will cause another EM tantrum or not
Medium term optimism for EM in spite of
short run pressures
• Medium term positive trends in EM:
– Urbanization
– Industrialization
– Population growth
– Per capita income growth
– Rise of middle classes and consumer society
• A larger share of global GDP and growth in EM
• High potential growth given by:
–
–
–
–
Demographic dividend (high population growth)
2nd generation reforms will boost competition and productivity
Ability to absorb existing and new technologies developed in DM
Technological innovation in some EM (Korea, China, India, etc)
Will the DM recovery soon lift
the growth in EM?
• Optimistic viewpoint: the strong recovery of DM
growth will soon lift – via trade channels – the
growth rate of EM (recoupling)
• Two reasons to be partially skeptic:
– The recovery of most DM will be somewhat anemic
(EZ, Japan). Soft data (PMIs) are stronger but hard
data (GDP, employment, demand) are still weaker
– If the DM recovery will be stronger the Fed may exit
zero rates faster and that will hurt the weaker EM
while benefitting the stronger ones via trade links
US growth is improving
• U.S. economy is in a tentative improvement growth
acceleration
• Q1 growth: -2.1%; Q2: 4.2%; 2014: 1.8% below a 2.3%
trend. H2 2014 and 2015 likely to average 3%
• Latest data on GDP, labor market, consumption,
investment, net exports are better but mixed
• Unemployment rate falling because of fall in labor force
participation rate and stronger job creation
• Fiscal drag is more modest now
• The rise in long rates in 2013 given taper talk crimped
growth of interest sensitive sectors (housing, capex) but
in 2014 long rates have fallen. Why?
• 2015 growth: Consensus: 3%.
Causes of US growth
acceleration
• More advanced deleveraging, easy Fed
policies, positive asset reflation, less
global tail risks
• Shale gas and oil revolution
• Re-shoring of energy intensive
manufacturing
• Stronger labor market with job creation
• Strong P&L and balance sheet of
corporate sector and banks
Some lingering US risks
• Structural reforms are not occurring
• Gridlock in Congress and partisanship
• Some households and young are still fragile
income-wise and debt-wise
• Could inflation rear its ugly head?
• Implications of the rise in inequality
• Risk of secular stagnation and why?
• Can economy sustain the rise in short & long
rates as the Fed exits & debt ratios are still high?
• Risk of credit/asset bubbles as Fed exit is slow.
Will macro-pru work?
The Macro-Pru Debate
• After GFC central banks care both about economic stability (strong
growth with low inflation) and financial stability
• Easy money justified by slow recovery has led to asset reflation that
can end up in asset bubbles
• Fed view: two targets and two instruments: monetary policy for
economic stability and macro pru for financial stability/avoiding
bubbles
• But macro-pru may not work as untested and hasn’t worked in the
past: only instrument that enters in all cracks of the financial system
is the interest rate instrument
• If macro pru doesn’t work: damn if you do and damn if you don’t as:
– Slow exit given weak recovery could cause the mother of all boom/bubbles that
will eventually go into a bust/crush
– OR:
– If macro pru doesn’t work and monetary policy is then used to prick the bubble
risk of a bond market rout and hard landing of the real economy
Eurozone outlook: less tail risks but
fundamental problems unresolved
• The recovery of the EZ after the GFC was weaker than
in the US given weaker policy stimulus
• The EZ relapsed in a double dip recession in 2011-2013
• The periphery of the EZ entered a severe financial crisis
with serious sovereign risks. Seven countries in trouble
and five bailed out (Greece, Ireland, Portugal, Spain,
Cyprus)
• Problems were initially in the private sector in Spain and
Ireland; in the public sector in Greece, Portugal and Italy
• Doom loop between the EZ banks and the sovereigns
• At the peak of the crisis in summer of 2012 risk of Grexit,
EZ break-up, loss of market access by Italy and Spain
EZ tail risks are lower today
• EZ tail risks are lower today thanks to:
– Draghi’s “whatever it takes”
– OMT program
– ESM program on top of EFSF and EFSM
– Beginning of a banking and fiscal union
– Germany realizing that EZ is also a political
project that requires time and patience
– Austerity and reforms supported by bailout
funds, both fiscal and monetary (ECB)
Some Positives in the EZ Today
• The EZ recession was over in early 2014 even if
recovery is anemic/weak/uneven
• A lot of fiscal adjustment is done and less fiscal
drag ahead
• Troika agreed to back load some austerity
• Beginning of structural reforms in some
• Internal devaluation (fall in Unit Labor Costs to
increase competitiveness) in some periphery
• Fiscal adjustment and reforms in exchange of
liquidity and bailout funds holding politically.
Grand bargain between core and periphery
The Negatives in the EZ
• Low potential growth given slow reforms
• Recovery after recession is fragile/weak/uneven.
H1 2014 growth was weak & H2 not good
• Public and private debts are still high and rising.
Debt sustainability issue
• Loss of competitiveness has not been fully
reversed. Improvement in trade balances is
partly cyclical (recession)
• Still credit crunch in periphery banks with late
AQR and stress tests
• Still fiscal drag even if if diminished
The Negatives in the EZ
• EZ is at risk of deflation
• A monetary union requires a banking, fiscal,
economic and political union to be viable in the
long run
• Some limited progress on the banking union
• Austerity fatigue in the periphery and bailout
fatigue in the core
• Political risks in the periphery are high
• The ECB is moving but too little too late; as
usual behind the curve. Only now moving
towards QE and CE
“Draghinomics” looks like
Abenomics
• Draghi: Slow growth depends also on
aggregate demand not only on supply
constraints (slow reforms)
• Three arrows: QE and CE; fiscal stimulus
in short run with continued medium term
consolidation; structural reforms
• ECB will do its share: effective QE and CE
• The fiscal stance will remain too restrictive
• Asymmetric adjustment of EZ continues
Abenomics is partially working in
Japan but many risks remain
• Abenomics has partially worked:
– Deflation ending
– Growth picking up
– Yen weaker and stock market stronger
• Open issues:
– Will structural reforms and trade liberalization that
increase potential growth be implemented faster?
– The rise of the consumption tax in 2014 led to Q2
negative growth; will the 2015 tax hike go ahead or
not; and can the economy take it?
– Is Japan’s public debt sustainable in the long run?
– Will the BoJ do top up QE this year and into 2015-16?
China: Hard landing or soft landing?
• Will China experience a soft landing or hard landing or a
bumpy/rough landing?
• China’s growth is unbalanced and unsustainable: too
much savings, investment and exports; too little private
consumption
• Will the reforms decided at the November 2013 Third
Plenum of the Central Committee of the CCP be
implemented fast enough to rebalance growth?
• Reforms will be slower than optimal and desirable as
leadership is divided and resistance to change
• Risk of a harder landing than the consensus expects
(7.5% growth). Growth may slow down to 7% in 2014
and below 6% by 2016
Major E’s in the global economy:
The 2010-2014 period
•
•
•
•
•
•
•
•
Economy
Energy and oil prices
Exchange rates and external imbalances
Euro/Eurozone/ECB
Emerging Markets
East as Middle East
East as East Asia
Earnings/Equity markets
Economy (global) during the Global
Financial Crisis (GFC)
• The US and the global economy experienced in 20082009 their worst recession in decades
• The housing and mortgage bust led to an economy wide
recession in the US as there were spillovers of the
housing recession to other sectors of the economy
(autos, manufacturing, consumer durables)
• The liquidity and credit crunch that started in the subprime mortgage market spread to all credit and financial
markets as this was not just a sub-prime problem: subprime, near prime and prime mortgages, commercial real
estate mortgages, credit cards, auto loans, student
loans, leveraged loans
• Also the US consumers (consumption is 70% of
aggregate demand) were shopped-out, saving-less and
debt-burdened
Economy (in the GFC)
• This was both a liquidity crunch and a credit crunch the
driven by serious solvency problems given over-leverage
of households, financial institutions and parts of the
corporate sector
• The myth that the rest of the world could decouple from
the US recession was shattered in 2008: there was
massive re-coupling first in financial markets and then in
the real economy. Recession in most advanced
economies (US, Eurozone, Japan); recession or massive
growth slowdown in emerging market economies)
• The Great Recession of 2008-09 bottomed out in late
2009 when most economies started to recover. But the
recovery in DM since then was been anemic, sub-par,
below trend, a U-shaped recovery. Stronger in 2015 as
deleveraging more advanced?
Causes of the housing/credit
bubble and bust/crisis
• Easy monetary policy (the Fed tightened too little too
late)
• Lax supervision and regulation of the financial system
• Excessive risk taking and leverage of the financial sector
given distorted incentives
• Global current account imbalances and global savings
glut
• Irrational exuberance and animal spirits leading to
bubbles
• Government subsidization of housing (tax benefits, role
of Fannie and Freddie, Community Reinvestment Act)
• Distorted incentives of rating agencies
Energy
• US/global recessions have been associated with oil
price spikes (1973-74, 1979-80, 1990-91, 2000-2001).
• In 2008 oil prices spiked again (to $145 a barrel in the
summer). This increase in oil prices was not driven by
economic fundamentals but, in part, by speculation
• The high oil prices were one of the factors that triggered
the global recession as they represented a negative
terms of trade and real disposable income shock for oil
importing economies (US, Eurozone, Japan, China, etc.)
• Once the global recession emerged oil and energy (and
commodity) prices collapsed (oil down to $30 at the
bottom).
• Since then oil prices recovered and are recently hovering
around $100 as the global recession bottomed out and
then recovered. But recent softening of prices
Exchange rates and External
imbalances
• The strength of the U.S. in the 1990s relative to Euro,
Yen and other currencies led to a large a growing current
account deficit in the US as the US lost competitiveness
• After 2000, the US current account deficit worsened
further as the fiscal deficits mushroomed (“twin deficits”)
and as the private savings rate sank close to zero
• This led to the debate on whether this current account
deficit was sustainable or was going to lead to a crash in
the value of the US dollar and/or a spike in US interest
rates (dollar hard landing)?
• The dollar started to decline in 2002-2004, especially
relative to the Euro, but then it sharply appreciated again
in 2005 as interest rates and real growth differentials
favored the $ relative to the euro and the yen.
• But the dollar resumed its fall in 2006-07 when the US
had a growth slump, a financial crisis, and the Fed cut
the Fed Funds rate starting in the fall of 2007
Exchanges rates and External
imbalances
• The global current account imbalances were one of the
causes of the global financial crisis
• The dollar started to appreciate during the financial crisis
of 2008 as panicked investors were seeking the safety of
dollar assets. When risk is off the dollar goes up
• The US trade deficit also started to shrink as the fall in
consumption led to a fall in imports. But was this
improvement mostly cyclical or structural? Is shale gas
a game changer for the U.S. external balance?
• Will the further adjustment of global current account
imbalances continue or be reversed?
• Is the risk of a dollar crash if foreign investors – who
were financing the US twin deficit became concerned
about the sustainability of such deficits – now lower as
the US twin deficits have been shrinking?
• Will Dollar strengthen now that US growth is picking up?
Europe/Euro/ECB (2000-2012)
• Growth was sluggish in Europe in the 1990s relative to
the U.S. given structural impediments to growth
• Recovery of European growth after 2005
• The Euro showed significant weakness relative to the US
dollar until mid 2002 as the Eurozone growth was
weaker than US growth.
• The Euro then sharply appreciated until the end of 2004
(by about 40%), and again in 2006-07 (after a brief dollar
rally in 2005)
• During 2008 not only Europe did not decouple from the
US crisis but the recession in the Eurozone was more
severe than in the US
• This was in part due to the fact that the policy easing in
Europe (monetary and fiscal) was not as aggressive as
in the US
Europe/Euro/ECB
• Fiscal stimulus in Eurozone was weaker because many
of the member countries start from large fiscal deficits,
large stocks of public debt and banks that are too big to
fail and too big to be saved
• ECB easing during and after the GFC was weaker than
the one of the Fed as the ECB has a single mandate of
price stability.
• The recovery of growth in the EZ was even more anemic
than the one of the US given less easy monetary policy,
early fiscal tightening and unresolved bank problems
• Sovereign debt problems in the EZ and the EZ crisis
• Potential growth for the Eurozone is low – 0% to 1.5% in
the periphery - and possibly falling because of structural
rigidities. EZ at risk of near deflation now.
• What are the prospects for structural reforms in Europe?
• Will QE and CE prevent deflation and restore growth?
Emerging market economies
(2000-2013)
• Emerging market (EM) economies experienced many
economic and financial crises in the 1994-2002 period
• 2001 was a dismal year for emerging market (EM)
economies. The slowdown of growth in US and G7, the
tech bust and the reduction of flows of capital to
emerging markets led to a sharp slowdown of growth in
many emerging markets.
• Outright currency and financial crises emerged in Turkey
(February 2001) and Argentina (December 2001). In
2002, severe pressures mounted in Uruguay and Brazil;
Uruguay experienced a severe financial crisis in 2002;
Brazil barely escaped a financial crisis as elections
loomed in late 2002 but then it recovered after Lula
followed moderate policies.
Emerging market economies
• Emerging market (EM) economies’ growth recovered sharply in
2004, especially in Asia but also in Latin America. Important role of
macro and financial reforms after the EM crises in this growth
recovery
• 2004-2007 were excellent years for EMs as global conditions were
ideal: global growth was high, global interest rates were low,
commodity prices were high and global investors’ risk aversion low
(search for yield).
• The financial crisis to a massive re-coupling – financial and real - of
emerging markets with advanced economies: many emerging
markets entered a recession and others had a massive growth
slowdown.
• Financial and economic crises in Emerging Europe
• The recovery of growth in some emerging markets – China, India,
some other parts of Asia, Brazil and parts of Latin America – was
earlier and faster than advanced economies as their macro and
financial fundamentals are robust. A V-shaped recovery
• But in 2013-14 many EM faced slowdown & financial pressures that
diminished after Feb 2014. Will Fed exit lead to another tantrum?
East as in Middle East
• Further turmoil in the Middle East (the Syria and Iraq
security situation; the Arab Spring; tensions between
Israel and its neighbors; the risk of a military
confrontation between Israel/US and Iran on the nuclear
issue) could affect oil prices if the fear premium rises.
• The Middle East is an arc of instability that goes from the
Maghreb all the way to Af-Pak
• Also, such oil market turmoil could affect skittish
investors’ mood and consumer confidence as it
increases uncertainty and reduces real incomes.
• The Middle East and oil prices are a major source of
geo-political tension on global markets.
• Previous US and global recessions have been
associated with stagflationary oil price shocks
• But so far markets have ignored the geopolitical risks in
the Middle East? Why? Will this change or not?
East as in East Asia
• China experienced rapid economic growth and
overheating in the 2003-2008 period
• The GFC led to a massive growth slowdown in China in
the fall of 2008. But the aggressive policy reaction of
China led to a robust growth recovery. But China risks
now a hard/rough landing unless it changes its growth
model fast enough
• India’s dynamism in IT contributed to high growth in last
decade. But India now faces severe fiscal problems and
need for major structural reforms. Growth slowed down
sharply after 2012. Will the new Modi government
accelerate reforms?
• East Asia growth strongly depends on China and the
US. A number of Asian EM may be at risk
• Japan’s recession in 2008-09 was very severe and the
recovery anemic. Will now Abenomics work or not?
Earnings/Equity markets (2004-2009)
• Equity markets in the US and globally did well in the
2006-2007 given high global economic growth
• High earnings growth, much improved corporate balance
sheets, easy monetary conditions supported equities
• Profits sharply increased as a share of GDP
• But during the recent global financial crisis US and
global equities sharply fell (by over 50% btw the fall of
2007 and March 2009) with a bear market that
experienced a number of bear market rallies.
• Since March 2009 a massive rally in U.S. and global
equity markets (over 100%). Is it excessive and at risk of
a significant correction or bound to rise further?
• Some disconnect between slow recovery of the real
economies and rapid rise in equity prices.
Earnings/Equity markets
(2010-2014)
Background on US equity markets in the 2000-2014 period:
• The U.S. and global economic slowdown in 2001 led to a sharp slowdown of earnings
and underperformance of equity markets (on top of the dotcom bust and Nasdaq
collapse in 2000).
• Equity markets also underperformed in 2002 as the stock market rally after the 9/11
drop was excessive and based on overoptimistic expectations of growth.
• Stock markets slumped again in the first quarter of 2003 as the concerns about a war
with Iraq led to renewed risk aversion.
• But they then recovered sharply after the war in 2003 as markets started to expect a
sustained economic recovery and a sharp pick-up in profits and earnings.
• But stock indexes remained mostly flat on average in 2004 and even in 2005 and
2006 (with only a modest uptrend since 2004) even if corporate balance sheets have
improved sharply (with debt de-leveraging) and earnings growth has been sustained
in 2004-2006.
• Equity markets – in the US and abroad – rallied sharply in 2006-2007
• Bear market in equities starting with the financial turmoil in the fall of 2007
• Bottom of the bear market in March 2009 and then rapid recovery through 2013 with
some episodes of risk off followed again by risk on.
• In 2013 sharp rally of US equities that continued at a slower pace in 2014.
• Is the US stock market overvalued? Will a correction occur or will it continue to trend
up and by how much in 2015 and beyond?
• Will profit margins shrink and earnings growth slow down?
Linkages between the U.S. and the rest of
the world occur via various channels
• Trade
• Capital flows and FDI (Europe, Japan, Emerging
markets)
• Value of the US dollar
• US monetary and fiscal policy
• Global stock markets and financial links
• Developments in oil and commodity markets
• Political shocks and risks
• Global investors and corporate confidence
Fed policy: 2000-2014
• The Fed reduced the Fed Funds rates 11 times in 2001,
by 475pbs to a rate of 1.75% as the economy entered a
recession.
• Faltering in the US recovery in the fall of 2002 led the
Fed to cut the Fed Funds again, down to 1.25% in
November 2002 and down to 1% in June 2003 as a
jobless recovery emerged during the war with Iraq.
• In 2004, as growth of output and jobs picked up and
inflation started to increase, the Fed started to increase
the Fed Funds rate in 17 consecutive steps bringing it to
5.25% by June 2006 and then pausing in August 2006.
• The risk of a US hard landing and the market turmoil in
the summer of 2007 led the Fed to cut rates starting in
the fall of 2007 from 5.25% to effective 0% in 2008
• Massive quantitative easing in 2008-13 during and after
the financial crisis: unconventional monetary policy. Fed
started tapering QE in Dec 2013. When will it exit ZIRP?
US fiscal policy since 2008
• Fiscal stimulus package in 2008 as the economy entered a
recession
• As second $900 billion fiscal stimulus package legislated in early
2009
• Deficit for 2009 rose to be $1.4 trillion but is now much lower ($600
bn) or 4% of GDP in 2013
• Fiscal path – deficit and debt - is clearly unsustainable as over the
next decade deficits will rise again unless entitlement spending is
reformed (Social Security and Medicare)
• Difficult issue of when to exit from the fiscal stimulus. The U.S.
postponed till 2012 but serious fiscal drag in 2012-13 given
spending cuts/sequester and rise in taxes
• 2013 showdown on government shutdown and debt ceiling
• Will fiscal fights in Congress resume in late 2015 if Republicans win
the Senate in 2104 mid term election?
• Or will another compromise on the sequester be achieved for 2016
and beyond?
Global current account imbalances
• Are the global current account imbalances (still large deficit in the
US and fragile EM, large surpluses in Europe, China and many
emerging market economies) sustainable over time?
• Is the US current account deficit and external debt accumulation
sustainable? It is shrinking but maybe too slowly?
• Will the adjustment of global imbalances be orderly or disorderly?
• Is the global current account adjustment to asymmetric as deficit
countries need to retrench while surplus countries aren’t reducing
their surpluses? Is this deflationary for the world?
• How will the major currencies ($, Yen and Euro) perform? Will the
dollar weaken or strengthen over time?
• Is the recent 2104 dollar strength sustainable and how will it affect
the US external balance?
• Is the risk of a hard landing of the US dollar - especially if the
foreign creditors of the US get tired of financing the US twin fiscal
and current account deficits – reduced as the twin deficits are
smaller?
Global deflation or inflation?
and commodity prices
• Until 2007 and early 2008 there was concern about global inflation
as global growth was robust, emerging market economies were
overheating and experiencing double digit inflation (30 plus
countries) and as commodity prices were rising
• But once the US recession became global in the second half of 2008
serious deflationary pressures emerged in the global economy
because of slack in goods markets, slack in labor markets and
sharply falling commodity prices
• By spring of 2009 economies experiencing actual deflations
included US, Eurozone, Japan, China and a number of other
advanced economies and emerging markets
• Will inflation return as the global economic recovery may accelerate
in 2015 and beyond? Or are disinflationary forces stronger?
• Will inflation surprise to the upside in the US and cause the Fed to
be behind the curve regarding exit from zero rates?
• Should we worry more about inflation or about deflation and over
which time horizon should we worry more about one or the other?
• Is the commodity super-cycle really over?
Some of the cutting edge issues (and jargon terminology
used) in international macro policy debates
• Why did the subprime crisis lead to a wider credit crunch?
• Was the crisis due to a liquidity crunch or a credit crunch/solvency
crisis?
• What is the risk of a another systemic crisis and what factors trigger
one?
• What causes asset bubbles? What causes housing bubbles and
bust?
• How should monetary policy react to asset bubbles and asset
bubbles bursting? Should central banks address bubbles with a rise
in interest rates or via macro-prudential supervision and regulation?
• Should we worry about deflation or inflation?
• How will central bank exit unconventional monetary policies (ZIRP,
QE, CE, FG)?
• What is the risk of sovereign debt crises in developed markets?
• Why is income and wealth inequality rising and what is the impact of
it?
• Are advanced economies at risk of secular stagnation and why?
Some of the cutting edge issues in
international macro policy debates
• Should we worry about stagflation or stag-deflation?
• Are global external imbalances sustainable or not, and for how
long?
• Are twin fiscal and current account deficits sustainable in DM and
EM?
• Should we worry about asset protectionism and restrictions to FDI?
• Should we worry about capital controls on inflows and outflows?
• Should we worry about resource protectionism?
• What is the future of offshore outsourcing?
• Is the trade liberalization Doha round as dead as Dodo?
• Is free trade compatible with flexible exchange rates or does greater
trade integration require managed or pegged exchange rates?
• Is globalization at risk of reversal?
• Should we be optimist or pessimist about the pace of future
technological innovation?
Some of the cutting edge issues in
international macro policy debates
• What is the BBC (Basket, Band and Crawl) exchange rate regime
allegedly chosen by China?
• Are highly-leveraged institutions and hedge funds a source of
systemic risk?
• What is the risk of new asset and credit bubbles?
• Is housing frothy and bubbly in some economies?
• Will macro-pru be effective in ensuring financial stability or not?
• Is offshore outsourcing a threat or a benefit for the global economy?
• Will the BRICs dominate the world economy in the next decades?
• Is the balance sheet approach the appropriate framework for
thinking about financial crises in emerging economies?
• Are crises due to fundamentals or self-fulfilling liquidity runs?
• What explains sudden stops and reversals of capital inflows?
• What explains the joint eruption of currency, sovereign debt,
systemic banking and systemic corporate crises?
Some of the cutting edge issues in
international macro policy debates
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What is the appropriate form of PSI/bail-in/burden-sharing in crisis
resolution?
Do we need an international lender of last resort (ILOR)?
What explains international contagion?
How to deal with liability dollarization and original sin?
Do we need an international bankruptcy regime for sovereigns?
What is the most desirable sovereign debt restructuring mechanism?
Do emerging markets suffer of fear of floating and if so why?
Is unilateral dollarization the way of the future?
Are monetary unions feasible without broader banking, fiscal, economic and
political unions?
Is sterilization of excessive capital inflows feasible and desirable?
What is the desirable reform of the international financial architecture?
Will the US dollar remain the main global reserve currency?
Sources of International
Macroeconomic Interdependence
among Economies
• “Macroeconomics” is “international” given the
increasing economic interdependence among
countries and the increased globalization of
trade and finance.
• Trade links:
– Income effects on imports and exports of
goods and services
– Direct and indirect trade links
– Exchange rate effects on trade
Financial channels of
interdependence
• Assets/Liabilities traded internationally
– Stocks
– Bonds
– Derivative instruments (in the GFC)
• International financial markets/intermediaries:
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Banks
Capital markets (stock/bond/money markets)
Foreign exchange markets
Commodities markets
Interdependence channels via
common shocks and FDI/MNCs
• Common sectoral/external shocks
– Common oil and commodity shocks
– Tech sector technology shock in the mid 1990s and
bust in 2000-2001
– Housing bubbles in the US and other countries; and
their bust in 2007-09
– Global credit crunch
• Foreign Direct Investment (FDI)/ Multinational
Corporations (MNCs):
– Real investment (FDI, M&A)
– Output/production location decisions
Interdependence via Policy Links
• Domestic effects of macro policies
• International effects of domestic policies if a country is
large (US, Europe, Japan)
– Global financial contagion of 2008-2009
• International effects of domestic policies even if a
country is small (international contagion):
– Mexico Tequila effect in 1995
– The Asian fever/flu
– The Russian virus (contagion to emerging markets – Brazil,
LatAm - and advanced markets – LTCM & US capital markets)
– The Turkish influenza in 2001
– Greece, Iceland, Cyprus in 2010-12
Many Financial Crises in Emerging Markets
and G7 Economies in the last two decades
• Currency/Financial Crises in Emerging Markets:
– 1980s debt crisis in Latin America
– Mexico, East Asia, Russia, Brazil in the 1990s;
– Turkey and Argentina in 2001; Uruguay in 2002;
Brazil mini-crisis in 2002; Dominican Republic in 2003
– Market turmoil (mini-crisis) in EMs in May-June 2006
– Massive contagion of US financial crisis of 2008-2009
to emerging markets economies markets and
economic growth. Avoidance of outright financial
crises given stronger fundamentals
– EM mini crisis of 2013-14? Temporary or persistent?
Crises and financial stresses in
Advanced/G7 Economies
• S&L crisis in US in early 1990s
• Corporate/Banking crisis in Japan in 1990s after bursting
of the 1980s asset price bubble
• European Monetary System (EMS) currency crisis in
Europe in 1992-93 (Italy, UK, France, Sweden)
• Banking crisis in Finland and Sweden in early 1990s
• Bond market crash in the US in 1994 as the Fed
unexpectedly tightened monetary policy.
• Sharp fall of the value of the US dollar in 1994-1995
• LTCM crisis in 1998 and seizure of U.S. capital markets
Crises and financial stresses in
Advanced/G7 Economies
• Bursting of the US asset price bubble in equity markets
in 2000-2002; IT and dot.com crash.
• US corporate and accounting scandals in 2002-2003
(Enron, Sarbox legislation, etc.)
• GM-Ford downgrade in 2005 and turmoil in credit
derivatives markets
• Equity market turmoil in the spring of 2006 during the
“inflation scare”
• Housing bust and sub-prime crisis in the US (2006-2008)
• US and global financial markets turmoil and volatility
starting in the summer of 2007
• Global financial crisis and recession of 2008-2009
• Eurozone crisis of 2010-2013
• Risk of new asset/credit bubbles in 2014 & beyond?
Major macro and financial events of the last 20
years: Advanced Economies
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1987: Greenspan becomes chairman of the Fed. Stock market crash in the
US in 1987.
S&L (Saving and Loans) financial crisis in the late 1980s; evidence of a
“credit crunch” in the US.
US and global recession in 1990-91 during the Gulf War.
Persistent stagnation of Japanese economy in the 1990s (4 recessions in
the 1990s decade) after the bursting of the 1980s asset bubble
Currency crisis in the European Monetary System in1992-93
European Monetary Union (1999 introduction of Euro) and mediocre
economic/growth performance of Europe in the 1990s
Large swings in the value of G3 currencies ($, Yen, Euro)
Global financial crisis in 1998 following Russian crisis and LTCM collapse
“New Economy”, internet and technology boom: the U.S. boom years (19952000): high growth, low inflation, high productivity growth, low
unemployment rate, boom in equity markets, budget surpluses, strong
dollar, large current account deficits.
Bust of the IT bubble in 2000-2001; sharp fall of investment leading to
economic slowdown in the US.
Major macro and financial events of the last 20
years: Advanced Economies
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The oil shock in 2000 contributing to the global slowdown
Fed tightening of monetary policy between mid 1999 and mid 2000 as the
economy was “overheating”.
US slowdown and recession and global slowdown in 2001; it started before
9/11 but was exacerbated by it.
Third and final stage of EMU (“Euro” introduction) started in 2002.
A de facto “Bretton Woods II” regime since 2001 as China and Asia
effectively pegged their exchange rates to the U.S. dollar through
aggressive foreign exchange intervention.
Tentative U.S. and global economic recovery in early 2002 that slowed
down in the spring and in the fall. Slow growth in H1-2003 (given Iraq war
uncertainty); U.S. and global recovery in second half of 2003 and Q1:2004
but with poor job growth (“jobless recovery”). Higher US and global growth
in 2005-2006
Bursting of the US housing bubble and a housing bust since mid 2006. Subprime mortgage crisis in the US (2007)
US and global economic and financial crisis of 2008-2009
Anemic, sub-par, below trend U-shaped recovery in DM in 2010-2013
Double dip recession in Eurozone, UK and Japan in 2011-2012
Stronger recovery in advanced economies in 2015 and beyond?
Risk of new asset/credit bubbles as exit from ZIRP is too slow?
Major macro and financial events of the last
20 years: Emerging markets
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Latin American debt crisis (in the 1980s) and its solution (Brady Bonds) in
the late 1980s and early 1990s
Large capital flows to emerging markets in the 1990-95 period.
Transition to a market economy in Central and East European countries.
Mexican currency crisis in 1994-95
Asian currency and financial crisis (Thailand, Indonesia, Korea, Malaysia) in
1997-98
Russian financial and currency crisis (8/98) and its contagion to emerging
markets and advanced economies financial markets (LTCM)
Currency crisis in Brazil in 1/99
Financial turmoil and IMF rescue packages in Argentina and Turkey in
November-December 2000
Sovereign debt restructurings after partial/full default in Ecuador, Russia,
Ukraine and Pakistan in 2000-2001
Turkish currency and financial crisis in February 2001
Major macro and financial events of the last
20 years: Emerging markets
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Argentina currency and financial crisis and default of 2001-2002
Financial/currency crisis in Uruguay in 2002
Risk of a financial crisis in Brazil as October 2002 elections were looming. Financial
recovery after the election. Weak economic performance of Latin America in 2003
with growth recovery in 2004-2005.
Accession of 10 emerging markets (mostly transition economies) to the European
Union in 2004.
Rapid growth of emerging market economies in 2004-2006 on the back of
macro/financial reforms and benign global conditions (high global growth, high
commodity prices, low G7 interest rates). International investors rediscover emerging
markets.
Boom in commodity prices exported by EMs.
2006-2007: Africa as the new EMs growth story and asset class?
Turmoil in EM financial markets in May-June 2006, especially for countries with
external vulnerabilities
Bubbly equity markets in EM especially in China, India and Gulf states
Contagion of the US financial crisis to emerging market economies in 2008-2009.
Strong V-shaped recovery of EM in 2010-2012 given stronger fundamentals
Slowdown and financial pressures in EM starting in 2013 and into 2014slowdown of
China, end of commodity super-cycle, Fed talk about tapering, policies reducing
potential growth