Download The Global Financial Crisis

Center for Social and Economic Research
Marek Dabrowski
The Global Financial Crisis: Causes,
Transmission Channels and New
Challenges
Presentation for the Conference on “Impact of the Global Economic and Financial
Crisis on Armenia: Short- and Long-run Perspectives”, Yerevan, July 7-8, 2009
Plan of presentation
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Sources and nature of the crisis
Crisis dynamics
Channels of contagion (to emerging markets)
Vulnerabilities of CEE/CIS region
Length of crisis, after-crisis
New challenges for economic research
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Basic characteristic of the crisis
• Truly global financial crisis caused by
bursting several bubbles
• Started at core and is moving towards
periphery (opposite to 1997-1998 emerging
market crisis and similarly to the Great
Depression and 1972 US dollar crisis)
• Preceded by overheating of the world
economy
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Three major asset bubbles
• Housing bubble in US and other
countries
• Stock market bubble
• Commodity bubble
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250
1000
900
800
700
150
600
Home Prices
500
100
400
300
Building Costs
Population
50
200
Interest Rates
0
1880
1900
1920
1940
1960
1980
2000
100
0
2020
Year
Source: Robert Schiller Irrational Exuberance, Princeton University Press 2000 and subsequent updates
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Population in Millions
Index or Interest Rate
200
450
400
350
300
250
Price
200
-51% from
150
2000 peak
100
Earnings
1890
1910
1930
1950
1970
1990
Real S&P Composite Earnings
Real S&P 500 Stock Price Index
2000
1800
1600
1400
1200
1000
800
600
400
200
0
1870
50
0
2010
Year
Source: Robert Schiller Irrational Exuberance, Princeton University Press 2000 and subsequent updates
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Factors responsible for building bubbles
• Highly accommodative monetary policy of the US
Fed and other major central banks (fear of
recession and deflation in US in early 2000s)
• Mercantilist policies of many developing
countries backed by IMF recommendations to
build precautionary foreign-exchange reserves
• Second-round phenomena (e.g. recycling of oil
surpluses)
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Delayed and limited inflationary
consequences – why?
• Positive supply side shocks (effects of market transition in
many developing countries and post-communist world)
and global trade liberalization – downward price pressure
• Increasing demand for USD and EUR as global transaction
currencies
• Post-inflationary remonetization in emerging markets
(backed by international reserves)
• Absorption of excess liquidity by asset bubbles (asset
prices are not covered by CPI)
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Other institutional, regulatory, and microeconomic
factors responsible for the crisis
• Lack of international coordination of macroeconomic
(monetary) policies and financial supervision
• Sectoral segmentation of financial supervision
• Pro-cyclical prudential regulations (Basel 1 and 2)
• Risk assessment methodologies which were unable to
follow financial innovations
• Wrong incentives schemes (remuneration of management
in financial institutions, fees for rating agencies, etc.)
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Crisis timetable
• Summer 2007: subprime mortgage crisis, beginning of
collapse of stock exchange
• Early 2008: systemic crisis of financial institutions in US;
economic slowing down in US, EU and Japan but
continuing overheating in most of emerging markets
(high commodity prices, weak US dollar, accelerating
inflation)
• Summer 2008: a breaking point
– Bursting of commodity and all other bubbles
– Global crisis of financial institutions (bankruptcy of Lehman
Brothers)
– Recession in developed countries
• Fall 2008: crisis hits emerging-market economies
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How crisis has been transmitted to
emerging markets?
• Weaker global demand (trade channel)
• Fall of commodity prices (balance-of-payments, fiscal and
second-round domestic demand consequences)
• Global liquidity squeeze (credit channel)
• Troubles of “mother” financial institutions
• Increasing risk aversion
• Increased exchange rate volatility
• Crowding out financial resources by fiscal stimulus
• Decreasing demand for labor migrants
• Possible further turbulences (banking crisis, sovereign default)
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Vulnerabilities of CEE/CIS countries
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High level of trade and financial openness
Export monoculture (mostly basic commodities)
Deep recession in major destination markets (EU and Russia)
Poor business climate in many countries
Immature and fragile financial sector
Currency and time mismatches in corporate and household
sector
• Limited credibility of domestic currencies (high level of
actual dollarization/ euroization)
• Lax fiscal policy in good times/ no fiscal reserves apart from
Russia and Kazakhstan
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Length of crisis, after-crisis
• Has crisis reach the bottom?
• The crisis length depends on rehabilitation of financial
institutions
• Risk of overcoming crisis too quickly (lesson of 2001
dotcom recession)
• Risk of deflation spiral vs. risk of stagflation and building
the new bubbles (e.g. in commodity market)
• After-crisis growth slow or moderate (2003-2007 growth
rates over the potential)  necessity to increase growth
potential
• Fiscal challenges requiring adjustment in expenditure
policy (mostly social)
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Challenges for economic research/ analysis
• Shift from short- to long-term perspective
• More attention to interlinks between micro and
macro (e.g. interlinks between financial sector
regulations and monetary policy)
• Reassessing DIT and other monetary regimes
• More focus on global perspective and crosscountry dependence
• Lack of theoretical models and analytical
frameworks allowing to analyze global economy
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