The Global Financial Crisis: Why It Happened, and Options for - PowerPoint PPT Presentation

The Global Financial Crisis: Why It Happened, and Options for National and International Policy Change A comparative overview of the crisis and macro-economic policy responses so far Trevor Alleyne Western Hemisphere Department International Monetary Fund Barbados January 25, 2011

The world is recovering from the great recession, but huge challenges remain  The impact of the crisis  How did the crisis start  Why this recession is different  Policy Responses thus far  Policies to sustain the recovery  Lessons from the crisis 2

The Crisis — Impact on Growth Global growth fell sharply during the crisis everywhere in the world Global GDP Growth (percent, quarter-over-quarter, annualized) 14 IMF Forecasts 12 Emerging and 10 developing economies 8 World 6 Advanced economies 4 2 0 -2 -4 -6 -8 -10 2006 07 08 09 10 11 Source: IMF WEO (October 2010). 3

The Crisis — Impact on Trade World trade collapsed… Growth Rate of World Real Imports (percent, quarter-over-quarter seasonally adjusted annual rate) 60% World Advanced economies 50% Latin America Emerging asia 40% Other emerging economies 30% 20% 10% 0% -10% -20% -30% -40% -50% -60% 2007 2008 2009 2010Q1 Source: IMF WEO (October 2010). 4

The Crisis — Impact on Unemployment Unemployment rose sharply in developed and developing countries Global Unemployment Rate (percent) 8.50 Onset of the crisis 8.00 Advanced Economies 7.50 Emerging and Developing Countries World 7.00 6.50 6.00 5.50 5.00 4.50 2006 2007 2008 2009 Source: IMF WEO (April 2010). 5

The Crisis — Impact on the Wealth  Wiped out US$2.7 trillion in U.S. originated assets of financial institutions (15½ % of GDP)  Write-downs on global exposures are estimated at about $4 trillion (7% of GDP) 6

The Crisis — Impact on the Caribbean Severe recession followed by a slow recovery of growth… Caribbean: Real GDP Growth 1/ (annual percentage change) 20 20 TTO 15 15 VCT 10 10 SUR SUR GUY 5 5 0 0 BLZ BHS GRD -5 -5 ATG -10 -10 ATG -15 -15 2006 2007 2008 2009 2010 Source: IMF WEO (October 2010). 1/ Caribbean countries include Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago. 7

The Crisis — Impact on the Caribbean … higher unemployment… Caribbean: Unemployment Rate 1/ (percent) 20 20 Caribbean average Tourism-dependent 2/ BHS BHS 15 15 BLZ SUR BLZ 10 10 5 5 TTO TTO TTO TTO TTO Commodity-exporting 2/ 0 0 2006 2007 2008 2009 2010 Source: IMF WEO (October 2010). 1/ Caribbean countries include Bahamas, Barbados, Belize, Jamaica, Suriname, and Trinidad and Tobago. Data for Guyana and ECCU countries are not available. 2/ Tourism-dependent countries include all Caribbean countries, except for Suriname and Trinidad and Tobago, which are commodity-exporting countries. 8

The Crisis — Impact on the Caribbean … and a sharp rise of public debt/GDP ratios Caribbean: Public Debt 1/ (percent of GDP) 250 250 Tourism-dependent 2/ Commodity-exporting 2/ Caribbean average KNA KNA 200 200 KNA KNA KNA 150 150 100 100 90.6 86.5 85.5 78.2 80.5 50 50 SUR SUR SUR SUR SUR 0 0 2006 2007 2008 2009 2010 Source: IMF WEO (October 2010). 1/ Caribbean countries include Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago. 2/ Tourism-dependent countries include all Caribbean countries, except for Suriname and Trinidad and Tobago, which are commodity-exporting countries. 9

What caused the crisis? How did it start? Let’s look at where the crisis began… In U.S. and European banks 10

Crisis starts in advanced countries Weak supervision Lots of liquidity sloshing around Weak regulation Excess risk Advanced economies Asset Banking Credit Recession bubbles crises crunch 11

Failure at the policy and supervisory levels  Market discipline and regulations failed to keep up with innovation and leverage build up.  Belief in light-touch regulation based on the assumption that financial market discipline would root out reckless behavior and that financial innovation was spreading, not concentrating risk .  Macroeconomic policies did not respond to increase in systemic risk.  Central banks focused mainly on inflation, not on risks associated with high asset prices and increased leverage.  Leadership needed at the international level to detect and respond to risks. 12

Crisis spreads to emerging economies Advanced economies Asset Banking Credit Recession bubbles crises crunch Trade collapsed - Capital flows stopped Emerging economies Credit Recession crunch 13

The Crisis — Contagion to Emerging Economies through Bond Spreads Bond spreads in emerging economies also increased Sovereign and Corporate Bond Spreads 1/ (basis points) 1400 1200 Advanced Economies: 1000 Corporate 2/ 800 600 400 200 EMBI Global 0 -200 2007 2008 2009 Sep-10 1/ The sovereign bond spread series for advanced economies is a composite of the five-year U.S. Treasury rate over the effective federal funds rate and the five-year German Bund over the EONIA rate. 2/ Averages of BB-B US, BB-B Euro, and BBB Japan corporate bond spreads. 14

Jamaica: Spreads and Domestic Interest Rates 15 45 1400 Spreads and Domestic Interest Rates 1/ 40 Money Market 1200 35 T-bill 30 Spreads, bps(RHS) 1000 25 800 20 15 600 10 400 5 0 200 2002 2003 2004 2005 2006 2007 2009 2010 1/ Spread refers to JPMorgan Central American and Caribbean Index (CACI) Jamaican stripped spread, which is calculated as the spread between a portfolio of Jamaican USD denominated bonds and on-the-run US treasury zero-coupon rate.

Low-income countries Advanced economies Asset Banking Credit Recession bubbles crises crunch Trade collapsed - Capital flows stopped Emerging economies Credit Recession crunch Low-income economies Recession 16

Why is this recession different?  Recessions associated with financial crises are severe and recoveries from such recessions are typically slow. These features become more pronounced if in addition the recession is global.  Countercyclical policies are helpful in ending recessions and strengthening recoveries. Their effectiveness depends on the type of recession. 17

Features of Recessions and Recoveries Depend on the Type of Recession… Recoveries Recessions Time until recovery to previous peak Output loss (percent from peak) (quarters) Output gain after four quarters (percent from Duration (quarters) trough) All recessions All recessions Financial Financial crises crises Highly Highly synchronized synchronized recessions recessions Financial Financial crises which crises which are highly are highly synchronized synchronized 0 2 4 6 8 0 2 4 6 8 18

Policies Help Shorten Recessions… Fiscal Stimulus is Effective in Financial Crises… Probability of remaining in a recession beyond a certain number of quarters 1.0 Financial crises 0.8 Financial crises with 0.6 Full sample high fiscal response 0.4 0.2 0.0 0 1 2 3 4 5 6 7 8 9 10 Quarters 19

Most countries implemented a fiscal stimulus to respond to the crisis Central Government Fiscal Deficit (percent of fiscal year GDP) 20 2009 2010 15 10 5 0 United Germany Canada States France Italy Japan Kingdom Ireland Portugal Spain Greece United Source: IMF WEO (October 2010). 20

To sustain the recovery, central banks have kept policy rates at historically low levels Policy Interest Rates (percent) 12 2010 Average (2001-2010) 10 8 6 4 2 0 United Australia Germany Iceland Italy Canada Denmark Euro Area Japan New Zealand Norway Sweden Kingdom States United Source: Haver Analytics, Inc. 21

In the Caribbean, high public debt/GDP ratios have weakened growth and narrowed the fiscal space Growth has been weaker in ... where fiscal space remains countries with higher debt levels... constrained. Change in Primary Deficit and Primary Public Debt Burden and Real GDP Growth Expenditure Growth, 2010 6 6 Change in primary deficit (percent of GDP)¹ Real primary expenditure growth minus Average real GDP growth, 2009 – 10 4 4 DOM potential GDP growth (percent, right scale) 2 10 2 2 1 5 DMA 0 VCT 0 0 0 JAM -1 -5 TTO BHS -2 -2 LCA -2 -10 HTI BRB GRD -4 -4 KNA -3 -15 -6 -6 -4 -20 10 40 70 100 130 JAM BHS BRB ECCU DOM TTO Public Debt, 2008 (percent of GDP) 22