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The Great Moderation, the Great Panic and the Great Contraction Charlie Bean Deputy Governor, Bank of England Barcelona, 25 August 2009 1. International credit expansion Financial liabilities of household and business (% of GDP) 250 200 Germany Spain UK France US Household and corporate sector US Financial sector 250 200 US 150 150 100 100 50 50 0 0 1995 1997 Source: OECD 1999 2001 2003 2005 2007 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: Federal Reserve, Flow of Funds 2. Financial innovation Stock of CDS outstanding Off-balance-sheet issuance $ billions 3,500 CDO issuance 1996 US$ trillions 70 Non CDO ABS issuance CMBS issuance 3,000 60 2,500 50 RMBS issuance 2,000 40 1,500 30 1,000 20 500 10 0 0 1998 2000 Source: Dealogic. 2002 2004 2006 2008 04H2 05H1 05H2 06H1 06H2 07H1 07H2 08H1 08H2 Source: Bank for International Settlements. (a) Notional principal of outstanding credit default swaps. 3. Real house prices Q1 1980 = 100 Australia France Germany Ireland Spain Switzerland 350 United Kingdom United States 300 450 400 250 200 150 100 50 0 1980 1985 1990 1995 Source: Bank for International Settlement 2000 2005 4. The Great Moderation Output and inflation volatility in the G5 UK: K US: S Japan: J Germany: G Standard deviation of inflation 6 5 K J 1970-92 4 France: F F 3 S 2 1993-2007 K 1 G SG J F 0 0 1 2 Standard deviation of output growth Source: ?? 3 5. The Great Moderation and risk perceptions Implied volatilities from options – standardised to zero mean and unit variance 4 MOVE 3 VIX 2 1 0 -1 -2 2000 2001 2002 2003 Source: Bloomberg and Bank calculations 2004 2005 2006 2007 6. Overly Loose Monetary Policy? Deviation of policy rates from Taylor rule 5 Percentage points Euroarea UK US 4 3 2 1 0 -1 -2 -3 -4 -5 2000 2001 Source: OECD 2002 2003 2004 2005 2006 2007 2008 2009 7. Global imbalances Current accounts (% of GDP, 5-year rolling average) UK Japan China US Germany Percent of GDP 10 8 6 4 2 0 -2 -4 -6 -8 1950 1960 1970 Source: IMF and national sources 1980 1990 2000 8. Long-term real interest rates Real 8.5 year government forward rates Per cent 6 5 4 3 2 UK US 1 0 1990 1993 1996 1999 Source: Bloomberg and Bank calculations 2002 2005 2008 Percentage growth in real house prices (2000 Q1 - 2007 Q4) 9. Real house prices & current accounts 10 Spain United Kingdom New Zealand France Australia Sweden Belgium Ireland Norway Canada 5 United States Italy Finland Switzerland 0 Germany Japan -5 -10 -5 0 5 10 15 Current account/GDP (average 2000 Q1-2007 Q4) Source: Bank for International Settlements 20 RK = (1+λ)RL – λRD 10. Defaults on US sub-prime mortgages Default rate by cohort of origination 2001 2002 2003 2004 2005 2006 2007 3 6 9 12 15 18 21 24 27 30 33 Months After Issuance Per cent 24% 22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 36 S o urc e : M o o dy's Inve s to rs S e rvic e . (a ) Adjus ta ble ra te m o rtga ge s , re la tive to o rigina l ba la nc e . 11. Pay-offs & prices on CDO tranches Tranche payoff Maximum payoff Price (per cent of par) 120 100 80 S0 60 AAA AA A BBB BBB- 40 20 0 K3 K2 K! ST Jan. Apr. Jul. Oct. Jan. Apr. Jul. Oct. Jan. Apr. Jul. 2007 08 09 Source: JP Morgan Chase & Co. (a) Each index references 20 home equity loan (HEL) ABS of indicated rating issued in 2005 H2. Sub-prime mortgages form the vast majority of the collateral backing HEL ABS. 12. CDS spreads for major financial institutions HSBC RBS Citigroup Goldman Sachs Deutsche Bank UBS Lehman Brothers Basis points 800 700 600 500 400 300 200 100 0 Jan. Apr. Jul. Oct. Jan. Apr. Jul. Oct. Jan. Apr. Jul. 08 09 2007 Source: Markit. (a) Five-year senior CDS premia. 13. The Great Panic: the flight to quality Spread between US Treasuries and Eurodollar rates 7 Per cent 7 Percentage points TED spread (lhs) 6 6 3-month T-bill yield (rhs) 3-month eurodollar rate (rhs) 5 5 4 4 3 3 2 2 1 1 +0 0+ -1 1- Jan. Apr. Jul. 2007 Source: Bloomberg Oct. Jan. 08 Apr. Jul. Oct. Jan. 09 Apr. Jul. 14. Expected losses get bigger & bigger… Financial sector writedowns on US originated assets $bn 3,000 2,500 2,000 1,500 1,000 500 0 Apr-08 Oct-08 Jan-09 Apr-09 S o urc e : IM F , Glo bal Financ ial S tability R e po rt, Wo rld Ec o no m ic Outlo o k , va rio us is s ue s . Es tim a te s o f po te ntia l write do wns fo r 2007-2010 o n US o rigina te d a s s e ts a s re po rte d in the GF S R a nd GF S R qua rte rly upda te s . 15. The Great Contraction Percentage changes on a year 12 earlier 8 4 0 IMF July 2009 WEO update forecast for 2009 and 2010 World real GDP grow th -4 -8 World trade volume grow th 1970 1975 1980 1985 1990 1995 2000 2005 Source: IMF World Economic Outlook -12 2010 16. UK financial network in 2007 Gross bilateral exposures 17. International financial network in 2005 External assets + external liabilities Source: BIS, IMF, OECD, UNCTAD and Kubelec and Sa (2009) 18. Total output loss in slowdowns & recessions Medians, % GDP 0 -1 -2 -3 -4 -5 Slowdowns Preceded by financial stress Not preceded by financial stress Source: IMF WEO October 2008 Recessions Preceded by financial stress Not preceded by financial stress The Great Moderation, the Great Panic and the Great Contraction THE END www.bankofengland.co.uk