Powerpoint ECOSOC

The Global Financial Crisis and Post-Crisis Challenges Jon Frost Financial Stability Division De Nederlandsche Bank (Central Bank of the Netherlands) TEIMUN Conference ECOSOC The Hague, 12 July 2011

Outline I.

DNB and its role in financial stability

II.

Origins and chronology of the global financial crisis

III.

The crisis and emerging and developing countries

IV.

Global and national policy responses

V.

The post-crisis recovery: new challenges

DNB and its role in financial stability •

•

•

DNB is an integrated central bank and supervisor of the Dutch financial sector – banks, insurers and pension funds “Everything in the service of financial stability”: • monetary policy (ESCB) • payments • prudential supervision • economic advice Financial Stability Division active since 2004: • signals risks to the financial system • writes semi-annual “Overview of Financial Stability” • active in policy formation on financial stability-related issues

Outline I.

DNB and its role in financial stability

II.

Origins and chronology of the global financial crisis

III.

The crisis and emerging and developing countries

IV.

Global and national policy responses

V.

The post-crisis recovery: new challenges

The global financial crisis: An overview • •

•

• • •

Since 2007, extraordinary stress in global financial markets Financial crisis has caused major economic dislocations, including global recession of 2009 (worst since the Great Depression) Origins lay in the US housing market bubble, but also in much deeper economic and financial factors Since 2009, also sovereign debt crisis in Europe Emerging and developing countries not at heart of the crisis, but also heavily impacted Major impact on global employment, welfare and attainment of development objectives (e.g. Millennium Development Goals)

Chart: GDP Growth by region In %, actual and projected, 1993-2012 10 8 6 4 2 0 -2 -4 1993- 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2016 2002 World Advanced economies Emerging and developing economies Source: IMF World Economic Outlook (April 2011)

Chronology of the crisis (selected) Sep. 14 2007: Bank run on Northern Rock (UK)

Jun. 18 2007: Two hedge funds owned by Bear Stearns forced to close due to subprime losses (US)

Oct. 7-9 2008: Icelandic banks Glitnir, Landsbanki and Kaupthing enter receivership (IS)

Sep. 15 2008: Request for Chapter 11 protection by Lehman Brothers (US) Sep.-Dec. 2008: Major losses in assets markets worldwide; capital outflows from emerging markets

Nov. 26 2009: May 20 2011: Debt Standstill at IMF/EU announce Dubai World (UAE) €78 bn program for Portugal (EU)

May 2 2010: Nov 28 2010: IMF/EU announce IMF/EU announce €110 bn program for€85 bn program for Greece (EU) Ireland (EU) Apr. 2 2009: London G20 Summit; world leaders announce package of measures to respond to financial crisis

Origins of the Global Financial Crisis: direct causes • •

• • • •

Huge housing bubble in US in early years of past decade (through 2007) Huge extension of “sub-prime” mortgages to (generally low-income) borrowers with limited or impaired credit history As house prices fell, wave of defaults, bursting of US housing bubble IMF estimate: over $1 trillion in losses from sub-prime assets, total bank losses of $2.8 trillion (2010) Period of uncertainty about distribution of losses (2007-8) “Hot phase” of the crisis, with bank runs and freezing of interbank market after default of US investment bank Lehman Brothers (September 2008)

Origins of the Global Financial Crisis: underlying causes (I) Chart 1: Consumer price index (CPI) inflation in the United States In %, average, 1970-2010

•

16 14 12 10

•

8 6 4 2 0 -2 1970

1975

1980

1985

1990

1995

2000

2005

2010

Source: US Dept of Labor Bureau of Labor Statistics

Chart 2: Current account balances of selected economies In billions of USD, 1990-2008

• • •

“Great moderation”: between 1980’s and 2007 – growth was robust and inflation was in control in many advanced (and increasingly emerging) economies Under the surface, growing “global imbalances” • “Exorbitant privilege” – role of US dollar as reserve currency, ability of US to run persistent current account deficits • “Global savings glut” – high savings especially in emerging Asia 2002-2007: growing “search for yield”, compression of risk premia Demand for USD assets Very low USD interest rates from 2003-5

Origins of the Global Financial Crisis: underlying causes (II) • •

• • • •

De-regulation of the financial sector Financial innovation – e.g. assetbacked securities (ABS), credit default swaps (CDS), collateralized debt obligations (CDO’s), structured investment vehicles (SIV’s), etc.

Rise of “shadow banking” – activities outside purview of supervision Increase in leverage in the banking sector (ratio of debt financing to equity – see chart) Increasing cross-border financial integration increased contagion channels between countries …

Current Sovereign Debt Crisis: underlying causes •

• •

• •

Persistent government deficits (borrowing) led to high public debt in many advanced economies before crisis In euro area, Maastricht criteria (limit of 3% of GDP deficit, 60% public debt) not adequately fulfilled Crisis hit both public revenue (taxes) and expenditures (e.g. unemployment insurance, bank recapitalization, etc.)

Large fiscal stimulus in some countries Worries about sustainability of public debt, especially in Greece, Ireland and Portugal (but potentially in other countries)

Chart 3: Gross public debt by country groupings In % of GDP, 2001-2015

Public debt and budget deficits: an overview Chart 2: Public debt and defict of selected economies In 2010, in % of GDP

220%

160

Japan

Greece

140

Italy

Public debt

120 100

Germany

80

Brazil

60

Ireland

United States

Canada

France

34%

United Kingdom

India

World

Spain Mexico

40 20

South Africa

China Russia

0 0

Source: IMF

2

4

6

8

Budget deficit

10

12

14

Outline I.

DNB and its role in financial stability

II.

Origins and chronology of the global financial crisis

III.

The crisis and emerging and developing countries

IV.

Global and national policy responses

V.

The post-crisis recovery: new challenges

Emerging and developing countries before the crisis •

•

• •

•

Strong growth and relative macroeconomic stability in many countries in 2002-7 period After crises in late 1990’s, declining public debt levels and increasing reserves (see chart) Especially rapid growth in Developing Asia (11.4% in 2007) and CIS (9%) Sub-Saharan Africa, Latin America, oil exporters also see strong growth, partly led by commodity exports (e.g. due to growing demand from China) Other economies negatively affected by rising oil and food prices, especially in 2007-8

The impact of the 2007-8 food (and oil) crisis • •

•

•

Food prices began rising rapidly in 2007 – rise of 140% through April 2008 Especially heavy impact on least developed countries and the most poor, who spend a relatively large share of income on food Oil prices peaked at $145 per barrel (WTI) in July 2008; collapsed to $30 only 6 months later in December Asymmetric impact on emerging and developing countries: oil exporters experience windfall, while others see huge pressures on balance of payments and government finances

Global investment flows have run a rollercoaster ride during the crisis Net Capital Inflows – All emerging market countries In $ billions, 4-quarter moving sum

Source: IMF, “Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes and Possible Policy Framework”, February 2011

…with significant impact on economies, financial markets and (real) exchange rates Real effective exchange rates of selected EMEs In %, jan 2008=100

120

100

Paul Krugman: “the mother of all currency crises” (26 October 2008)

80

60 Jan-07

Jul-07

Brazil Korea Thailand

Source: Datastream,

Jan-08

China Czech Republic Philippines

Source: Datastream, DNB

Jul-08

India Russia Poland

Jan-09

Jul-09

Indonesia Turkey

Jan-10

Jul-10

M exico Taiwan

The crisis had a heavy toll on growth for some regions Chart: GDP Growth by region - emerging and developing world In %, actual and projected, 1993-2002 and 2009 8 4 0 -4 -8 1993-2002 Central and Eastern Europe (CEE) Developing Asia Middle East and North Africa

Source: IMF World Economic Outlook (April 2011)

2009 Commonwealth of Independent States (CIS) Latin America and the Caribbean Sub-Saharan Africa

…but the recovery is much stronger than in advanced economies Chart: GDP Growth by region - emerging/developing vs. advanced In %, actual and projected, 2011 and 2016 12 8 4 0 2011 Central and Eastern Europe (CEE) Developing Asia Middle East and North Africa Advanced economies

Source: IMF World Economic Outlook (April 2011)

2016 Commonwealth of Independent States (CIS) Latin America and the Caribbean Sub-Saharan Africa

Outline I.

DNB and its role in financial stability

II.

Origins and chronology of the global financial crisis

III.

The crisis and emerging and developing countries

IV.

Global and national policy responses

V.

The post-crisis recovery: new challenges

Global policy responses (selected) • •

• •

•

Establishment of G20 as key policy forum for global economic issues Increased role of the IMF: • USD 250 billion allocation of Special Drawing Rights (SDR), USD 500 billion for New Arrangements to Borrow (London Summit, April 2009) • Enhanced role in surveillance • Key role in programs for euro area countries Financial Stability Board replaces Financial Stability Forum to coordinate work on issues of financial regulation and supervision Supervisory policy coordination: • Basel III capital accord for banks (Basel Committee of Bank Supervisors) • Solvency II introduced for insurers Sovereign debt crisis: • Establishment of €440 billion European Financial Stability Facility (EFSF), used to co-finance EU/IMF programs for struggling euro area member states

National policy responses (selected) •

•

•

Monetary policy: • major cuts to policy rates around the world • unconventional monetary policy (Quantitative Easing, full allotment) Fiscal policy: • automatic stabilizers and fiscal stimulus programs • since sovereign debt crisis, much more impact on consolidation Financial stability policy: • emergency recapitalization of banks and other financial institutions • liquidity assistance (e.g. through government guarantees, etc.)

• establishment of permanent funds for recapitalization or deposit insurance • major reforms to supervisory frameworks – establishment of financial stability committees and reorganizations of supervisory bodies

Outline I.

DNB and its role in financial stability

II.

Origins and chronology of the global financial crisis

III.

The crisis and emerging and developing countries

IV.

Global and national policy responses

V.

The post-crisis recovery: new challenges

Global imbalances: increasing again?

Since mid-2009, a major rebound in net capital inflows to (many) EMEs Financial account, CDS and EMBI spreads In $ millions (left axis) and basis points (right axis) Turkey: Financial account, CDS and EMBI spreads In $ million (left axis) and basis points (right axis)

Brazil: Financial account, CDS and EMBI spreads

Brazil

Turkey

In $ million (left axis) and basis points (right axis) 44000

560

36000

480

28000 20000

16000

-4000 -12000

800

20000

700

16000 Poland: Financial account, CDS and EMBI spreads 400 12000 320 In $ million (left axis) and basis points (right axis) 8000

12000 4000

24000

240

4000

160

0

80

500 400 300

500

-4000

0 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1

400

2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1

FDI

Portfolio

Other

CDS (r-as)

FDI

EM BI (r-as)

Poland

Other

CDS (r-as)

Romania

In basispunten, mln USD respectievelijk Bron: JP M organ, Datastream, IM F

16000 12000

Portfolio

Grafiek # CDS en kapitaalstroom

Poland: Financial account, CDS and EMBI spreads In $ million (left axis) and 8000 Bron: JP M organ, Datastream, IM Fbasis points (right axis) 500

4000

400

EM BI (r-as)

300

6000

900

4000

200

2000

8000

750 600

300 0

0

4000

200

0 -4000

200 100

-8000

0

12000

600

-4000

100

-4000

0

-6000

0

2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4Other2011Q1 CDS (r-as) FDI Portfolio

Portfolio

Other

FDI

CDS (r-as)

EM BI (r-as)

Portfolio

Bron: JP M organ, Datastream, IM F

Source: JP Morgan, Datastream, IMF, DNB Bron: JP M organ, Datastream, IM F

Other

300 150

2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1

2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1

FDI

450

100

-2000

CDS (r-as)

Bron: JP M organ, Datastream, IMF

EM BI (r-as)

0

Indicators of vulnerability?

Varying signals from different indicators, but some recurring (country) names

Source: IMF, Global Financial Stability Report, April 2011

Global recovery brings new challenges •

IMF warns of risks from “two-speed global recovery”: “The recovery is gaining strength, but unemployment remains high in advanced economies, and new macroeconomic risks are building in emerging market economies.”

•

Low interest rates and heavy global liquidity could be funding new “search for yield”, contributing to overheating in emerging markets

•

Commodity prices again rising, putting pressure on most poor and vulnerable

•

Need for “exit strategies” from policies enacted during the crisis

•

Importance of reforms to financial supervision and regulation

Questions?