FINANCIAL DYNAMIC, EURO AREA
DOUBLE DIP AND SECULAR STAGNATION
Michel Aglietta
Cepii
Changing the model of finance a prerequisite for a
sustainable growth regime
• Financial capitalism: an unsustainable system
– The financial cycle: momentum vs fundamental value
– Debt-induced asset price boom and endogenous crisis as “boom gone bust”
– Dearth of LT investors
• Euro area: inability to date to face the challenge of potential growth recovery
– Major errors of economic policy led to double-dip recession
– Private sector deleveraging has hardly begun
– The trap of secular stagnation is looming
• Conclusion; an innovative financial intermediation to revive productive
investment
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Global financial dynamic
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From the1980’s on, BIS research showed that financial
dynamic has been radically transformed (Drehmann et
Juselius)
•Before the1980’s: financial stability. The business cycle (measured by output gap changes)
fluctuates around potential growth
•After mid-1960’s inflationary drift because real interest rate <growth rate systematically while
productivity was slowing down
•From1980’s onwards: financial cycle: long period and large magnitude. Measured by a composite
index: private credit /GDP, private credit growth and real estate price variation
•The financial cycle is decoupled/ financial cycle →low inflation and stable growth (Great
Moderation) while financial disequilibria have accumulated inconspicuously.
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The financial cycle (17 countries) is driven by private sector
credit but impinges heavily upon the public debt
• LT <0 correlation between private and public debt, but in 1975-2000 shifting to >0
• The upward phase of the financial cycle (1996-2007) has been nurtured by the fastest
expansion in Credit/GDP for the last 130 years, while the ratio of public debt /GDP has
declined all over the period.
• The public debt surged in the financial crisis while it became systemic.
Public debt and bank credit to non financial sectors in 17 OECD countries
The financial cycle generates vulnerabilities within
the financial system
• The debt-induced asset price expansion is a momentum not a mean-reverting
process to fundamental value. The diverging momentum stems from
conventional behavior due to strong interactive influence under uncertainty.
• The price of risk covaries with expectations of the quantity of risk (market vol)→
accumulation of vulnerabilities:
– Structural: types of risks exposed to coordination failures which are nests of systemic
risk in the intertwined counterparty risk between shadow and regular banking systems
– Dynamic: financial intermediary leverage and maturity mismatch ↑ by recourse of
shorter and shorter debts to finance asset purchases without organic access to the
lender-of-last-resort
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Fundamental value is a notional price, not a marketdetermined price
• How could financial investors embody fundamental values in their strategic asset
allocation?
– The financial cycle is momentum-driven. Time-series analysis can reveal it over a full
cycle (15 to 20 years). It is well beyond of the timeline of political priorities in
representative democracies.
– Financial reforms worsen the impact of market volatility on the balance sheets of
financial institutions→ They make it more difficult the immunization of contractual
liabilities.
• Extra-financial risks cannot be accounted for in market values:
– Risks about intangible capital: demographic, long-run exclusion of labor market,
human capital downgrading
– Risks about natural capital: risk of breakdowns in ecosystems if unknown tipping
points are overstepped.
• LT strategic planning with strong democratic backing needed: discount rate set
very low to take care of future generations independently of market gyrations and
notional price of carbon setting→ sustainable growth.
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Euro area: unfit to meet the challenge
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European malfunctioning led to double dip recession
• The financial crisis in 2007-08 impacted the euro zone weakened by economic real
divergences between members exacerbated by EMU
• In 2009 Europe participated modestly to the global fiscal stimulation drive that
was effective to stop the spiraling depression in world trade
• In 2010, 3 majors errors of economic policy changed the course of the euro zone:
– The cleaning of bank balance sheet was delayed→ credit paralysis
– The Greek crisis was allowed to spread to solvent countries → vicious circle public
debt/ bank net wealth deterioration + money market fragmentation and freezing
– Much too fast restrictive fiscal adjustments→ recession (2011-13) → high multipliers
and ↑ in public debt ratios
• In 2014 feeble rebound unable to revive productive investment
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US/EA: the great divergence
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Failure to reduce debt and incomplete adjustment in
the euro zone
National debt
variation(%
GDP)
Private nonfinancial
public
Δ(2008-13)
Δ(2008-13)
US
-19
+22
EA
0
+13
-7
+6
-11
UK
Japan
France
Germany
Italy
Spain
GDP growth (%
average)
Current account
balance (%GDP)
2012-14
2012-14
US
2,4
-2,3
+26
+24
+13
+21
+54
EA
0,0
0,5
1,1
-1,2
-0,6
+2,0
-1,6
+7,4
+0,6
+0,3
-16
+34
UK
1,6
-3,9
-3
+46
Japan
1,4
+0,3
France
Germany
Italy
Spain
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The low-growth trap
Fiscal
austerity
Nominal rate
at ZLB
Investment ↓
Real income
stagnation
Thwarted private
deleveraging
Credit demand
decreases
Inflation ↓
Real interest
Rate ↑
Consumer
demand
feeble
exchange
rate ↑
LT unemployment
Human capital
deteriorates
Persistent
Weak demand
Potential
Growth ↓
Capital
Renewal ↓
TFP growth↓
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Need of a new financial intermediation
• A sustainable growth regime requires :
– Capital and technology transfers to finance the catching-up of EMEs
– Strategic asset allocation to finance ageing in advanced countries
– Financial mechanisms for investments in mitigation and adaptation to climate change
• Stricter prudential ratios and mark-to-market accounting impede banks and
institutional investors to take risks if robust risk sharing devices are not at hands
• Because of externalities, irreversibility and non-linear dynamics, market
accounting cannot be economically efficient for LT investment:
– It overvalues market risks in injecting ST market fluctuations into LT assets
– It biases internal rate of returns of investment projects in ignoring >0 and<0 externality
• Counting on market finance leads to conservative strategies→ new investment
channels and new financing instruments needed to share the risks:
– Carbon asset as legal reserve in the monetary system
– Carbon asset as collateral of new brand of Green Bonds of the highest rating issued by
a public financial intermediary (“Ecological Fund”) backed by public capital.
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