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Perspectives on Emerging Economies Growth Vincenzo D’Apice Observatory on Emerging Economies, Luiss 22-Feb-2011 Agenda 1. A framework for Boom & Bust Cycles: The Minsky Model 2. Perspectives on Emerging Market Economies Growth Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 The Minsky model Boom stage Starting Point: -Low inflation -Low unemployment Positive Shocks: -Deregulation -Financial innovation -Capital inflows Politicians & economists theorize the beginning of a new Era (e.g. New Economy) Banking Sector: -Demand for credit rises -Risk underestimation -Supply of credit rises Balance sheet channel Lending channel Financial accelerator (Bernanke-Gertler,’95) Financial Markets: -Asset prices rise (shares & real estate) -Wealth increases -Debt increases Animal spirits (Keynes 1937) Vincenzo D’Apice The Great Moderation (Bernanke ’04) -Covered -Speculative -Ponzi Real Economy: -Consumption rises -Investment raises -Lower savings -Rising current account deficit Boom: -Economy overheats -Real and/or financial imbalances grow -Financial structure becomes fragile Global Imbalances (Bernanke ’07) Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Minsky model Bust stage Starting Point: -Rising interest rates -Sudden change in expectations Default of Ponzi units Negative Shocks: -Capital flows away from more speculative investment Banking Sector: -Pessimistic evaluation of risk -Demand for credit falls -Supply of credit falls (crunch) Financial Markets: -Asset prices fall -Wealth falls -Debt deflation -Real debt increases Debt Spiral a la Fisher 1933 Vincenzo D’Apice -Central Bank -Government -Regulation Real Economy: -Consumption falls -Investment falls -Rising savings -Lower current account deficit Bust: -Banking crisis (bank runs) -Recession Deflationary Spiral Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 What is the Outlook for the Global Economy? • The outlook is: • U-shaped recovery in advanced economies • V-shaped recovery in emerging-market countries Output Growth (% ) World Advanced Economies Emerging Economies Vincenzo D’Apice 2010 5.0 3.0 7.1 Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 2011 4.4 2.5 6.5 2012 4.5 2.5 6.5 What Will Be the Role of Emerging Economies? •The role of EEs will be even stronger in the next decade (BRICs + N-11): $37t 45% $27t 30% $10t Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 30% What Will Be the Role of Emerging Economies? •One of the more striking story will be the rise of the new BRICs middle class: 2010 middle-class consumers purchasing power $7 trillion 2020 middle-class consumers purchasing power $20 trillion* Import goods of low value added Import of high value added goods (car, technology) Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 What Are the Downside Risks in This Scenario? • The first risk is further financial contagion in Europe: Spread over German Jan-2010 Jan-2011 (A) (B) 10y-bunds Greece 2.1% 8.0% Ireland 1.3% 6.0% Portugal 0.8% 4.0% Spain 0.8% 2.2% Italy 0.8% 1.8% Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Diff. (B-A) 5.9% 4.7% 3.2% 1.4% 1.0% What Are the Downside Risks in This Scenario? • The second risk is the negative effects of Fed QE: • FED QE* is subjecting the emerging economies to a flood of capital, rising commodity prices, inflation, and (possibly) asset bubbles: Fed Total Assets (trillion) Stock Growth Aug-2007 Feb-2011 0.9 2.5 1.6 178% Memo Vincenzo D’Apice US GDP 14.6 trillion Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 What Are the Downside Risks in This Scenario? • The third risk is that capital inflows to emerging markets will be mismanaged, thus fueling credit and asset bubbles: Capital Flows to Emerging Markets (% of world GDP) Capital Flows to Emerging Markets (% of world GDP) Net liabilities 2006 2008 2010 6,5% 1% 4% • Drivers: • Asset allocations • Carry trades Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 What Are the Downside Risks in This Scenario? • Flows into debt and equity mutual funds have been strong: Annual Retail Flows to Emerging Market Debt and Equity Mutual Funds ($ billion) • Risk of asset price bubbles • So, back to the twin crises of 90s? Yes & No • Yes, b/c the bust of the bubble can trigger a banking crisis • No, b/c the risk of currency crisis is low thanks to the accumulation of intl. reserves Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 What Are the Downside Risks in This Scenario? •The fourth risk is inflation in emerging markets: Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 What Are the Downside Risks in This Scenario? •The fifth risk is currency tensions (currency war): • Global imbalances will remain large • Deficit countries need a currency depreciation • But, surplus countries don’t want to accept a currency appreciation Global Imbalances (% of world GDP) • Deflation in deficit countries • Higher risk of debt default (via Fisher spiral) Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 What Are the Downside Risks in This Scenario? •The sixth risk is geopolitical (Korea, Pakistan, Tunisia, Egypt, Libya). • This risk is putting pressure on the price of commodities: • This, further inflation Vincenzo D’Apice in turn, will pressure put on Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 By the Way, Don’t Forget the Causes of the Recent Crisis • For example, the shadow banking system is still “shadow”: $16t $13t Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Why Do We Need Monitoring the Emerging Banking Systems? Global Imbalances EEs Strong Growth Rising MiddleClass Emerging Banking System Inflation GeoPolitical EU Debt Crisis Fed QE Capital Inflows Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Thank You Contacts: Vincenzo D’Apice [email protected] [email protected] [email protected] Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011