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Reinvigorating Economic Growth: Some Comments Sungmin Kim Graduate School of Finance and Accounting KAIST 2012. 12. 11 KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 1 Introduction We are living in extraordinary times After the crisis, everything appears to be changed completely From From From From “the Great Moderation” to “the Great Crash” “Globalization” to “De-globalization” “Leveraging” to “De-leveraging” “Deregulation” to “Re-regulation” At the same time, extraordinary times justify extraordinary measures Unconventional rather than conventional measures are mobilized more frequently Yet we are not quite sure how effective these measures are KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 2 2 Prospect of the Global Economy Even after several years passed, the crisis is still ongoing process Prospect of the global economy does not appear to be bright for the time being Almost every country is affected by aftermath of the crisis simultaneously Unusual uncertainties governing the global economy are still looming: black swans , grey swans and so on However, the worst case scenario is gradually phased out Some uncertainties have been eliminated as time goes by KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 3 3 Fiscal Austerity A measurement of debt sustainability: the amount of debt relative to income level So far, it is fair to say that the numerator has been overemphasized relative to the denominator of the measure An episode at the G20 CB Deputies dinner: Fiscal austerity in Greece Without adjusting FX rate, adjustment of nominal incomes & wages is an extremely painful process and not politically sustainable But no policy option is available to mitigate tightening effect of fiscal austerity Need to strike to balance between the denominator and the numerator of the debt sustainability measure KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 4 4 Exit Strategies for CBs It is too premature to discuss exit strategies for CBs When Korea was preparing for the presidency of the G20 in the second half of 2009, there were many talks about exit strategies At that time, many people thought that the crisis and global recession was over In the end, it turned out to be a false dawn Going forward, exit strategies will not be implemented in the near future and will be implemented in a very gradual manner KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 5 5 Cross-Border Capital Movements (1) Capital movements have become more volatile after the crisis Traditional theory: pull factor, which generally refers to improvements in the domestic economy’s prospects of host countries, plays a major role in determining capital inflows After the recent financial crisis, push factors, which are related to home countries, are arguably regarded as key driving forces in movements of capital flow The crisis situation in advanced economies has spilled over to EME in the form of capital flows In the phase of intensifying crisis situation in advanced economies, EMEs experience massive capital outflows, by deleveraging of financial institutions of advanced economies Local asset prices and currency decline sharply by massive sell-offs of local assets and currency By contrast, the phase of stabilizing crisis situation lead to massive surges in capital inflow to EMEs Local asset prices and currency appreciate sharply KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 6 6 Spill-over Process of Crisis to EME Phase of Intensifying Crisis Pessimistic Outlook of Growth in AE Acceleration of De-leveraging Triffin Dilemma Decrease of Export Increasing Losses of Foreign Investors Massive Sell-offs by Foreign Investors FX Shortage of Domestic Banks Dollar Crunch Decrease of Growth Sharp Drop of Asset Prices Instability in FX & Financial Markets Currency Depreciation Flight-to-Quality Surges in Capital Inflows Rapid Rise of Asset Prices and Currency Appreciation Optimistic Outlook of Local Economy Optimistic Outlook of Growth in AE Highlighting of Abundant Global Liquidity Phase of Stabilizing Crisis KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 7 Cross-Border Capital Movements (2) Although the relative importance of ’pull’ and ’push’ factors in capital movements continues to be debated, this volatile nature of international capital movements have raise concerns that volatile capital movements can destabilize economies In September 2010, Guido Mantega, the Brazilian finance minster, claimed that a currency war had begun between the developed economies and the developing economies In particular, the use of QE is very controversial Other things being equal, the increase in money supply that QE brings should make the currency worth less and thus lower the exchange rate KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 8 8 Cross-Border Capital Movements (3) Although imposing capital control appears very controversial, G20 need to explore when and how limits on cross-border investment might be justified Large, temporary capital inflow have been known to pave the way for big economic trouble One obvious risk is that incoming capital inflates bubble On the other hand, one risk from imposing capital controls is that they can be hard to roll back because they suit vested interests A more coordinated approach might mitigate the risks of the nastier spillover effects Coordination should extend to the countries that are exporting capital as well as receiving countries KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 9 9 New Approach to Financial Regulation (1) So far, the progress made on the ongoing G20 agenda for more resilient global financial system has been very comprehensive and impressive Nevertheless, more efforts should be focused on: 1. Completing the regulatory frameworks 2. Implementing them in a globally consistent way More efforts need to be focused on completing the regulatory framework in some areas which show lack of progress Strengthening and converging accounting standards Developing effective regulations on non-bank SIFIs and shadow banking KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 10 10 New Approach to Financial Regulation (1) If the reform process in these areas were to be further delayed, The associated regulatory uncertainty could jeopardize a recovery The potential for new risk to be emerged from these areas will be increased Regarding the implementation, need to keep in mind what history guides us The ongoing regulatory reform: “regulatory dialectics” A period of financial sector regulation until the early 1980s A subsequent period of deregulation After the recent financial crisis, entering into a period of re-regulation KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 11 11 New Approach to Financial Regulation (3) A critical question: Is this reform process sustainable? The answer depends on: Sustainability of the current regulatory reform in globally integrated financial markets and rapidly evolving financial industry Utmost important task: To make sure that regulatory arbitrage in both cross-border & cross-sector does not jeopardize the effectiveness of tighter regulation 1. Calls for more coordination of and cooperation at the international level 2. Need to build an effective system of regulating and overseeing the shadow banking system KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 12 12 New Approach to Financial Regulation (4) International coordination of financial regulation is particularly challenging, due mainly to different stage of financial sector development across countries This calls for sorting out minimum requirements of global standards that could effectively prevent crossborder regulatory arbitrage Another important task: to ensure that the pendulum does not swing back too far Some critics raise questions about the sustainability of the current regulatory reform Their arguments: many of the reform measures rely too heavily on financial sector taxation in the forms of capital regulation and capital surcharges on SIFIs Lead to a substantial increase in the cost of capital and jeopardize recovery KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 13 13 New Approach to Financial Regulation (5) At the same time, there is a strong case for maintaining the momentum of regulatory reforms Reversing or derailing could introduce another uncertainty, regulatory uncertainty Important to strike a balance between the risk of over-regulation and that of under-regulation It is more appropriate to reduce burden of financial industry as possible as we can Some suggestions for a more balanced approach 1. Greater emphasis should be placed on the reform of public policy to prevent future crises: building more robust macroprudential policy framework 2. To identify and correct institutional distortions which encourage leverage (e.g., tax)) 3. To address fundamental weaknesses in the corporate governance of financial firms KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 14 14 Thank You KAIST GRADUATE SCHOOL OF FINANCE & ACCOUNTING 15