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Western Hemisphere Department International Monetary Fund Barbados January 25, 2011

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.

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Western Hemisphere Department International Monetary Fund Barbados January 25, 2011

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

  2. The world is recovering from the great recession, but huge challenges remain • The impact of the crisis • How the crisis happened • Why this recession is different • The causes of the crisis • Policies to sustain the recovery • Lessons from the crisis • Main challenges faced by the Caribbean 2

  3. Emerging and developing economies World Advanced economies 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 10 8 6 4 2 0 -2 -4 -6 -8 -10 2006 07 08 09 10 11 Source: IMF WEO (October 2010). 3

  4. The Crisis—Impact on the World • Wiped out over $2 trillion in bank assets • Plunged most of the world into a global recession 4

  5. The Crisis—Impact on the World Over 30 million more people became unemployed (ILO) About 64 million more people have fallen into extreme poverty by 2010 (World Bank) 30-50 thousand more babies may die in Africa in 2010 (World Bank) 5

  6. 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). 6

  7. The Crisis—Impact on the Caribbean Severe recession followed by a slow recovery of growth Caribbean: Real GDP Growth 1/ (annual percentage change) 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

  8. The Crisis—Impact on the Caribbean … higher unemployment… Caribbean: Unemployment Rate 1/ (percent) Source: IMF WEO (October 2010). 1/ Caribbean countries include Bahamas, Barbados, Belize, Jamaica, Suriname, and Trinidad and Tobago. Data for ECCU countries are not available. 8

  9. The Crisis—Impact on the Caribbean … and a sharp rise of public debt/GDP ratios Public Debt 1/ (percent of GDP) 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. 9

  10. The Crisis Let’s look at where the crisis began… In U.S. and European banks 10

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

  12. Advanced economies affected (2009 growth rate) -5.1 -1.4 -6.8 -2.5 -4.7 -4.9 -4.1 -1.9 -2.6 -4.1 Euro Area -5.2 0.2 0.8 -1.9 -2.8 -1.3 1.2 -1.6 Source: IMF WEO (October 2010). 12

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

  14. Emerging economies affected (2009 growth rate) -13.9 -7.9 -18.0 -14.8 1.7 v -15.1 -6.3 -7.1 -4.7 9.1 -3.4 -6.5 5.7 -3.3 -2.2 1.1 -1.7 0.8 4.5 -0.2 0.9 -1.5 -1.8 0.9 Source: IMF WEO (October 2010). 14

  15. Low-income countries Advanced economies Asset bubbles Banking crises Credit crunch Recession Trade collapsed - Capital flows stopped Emerging economies Credit crunch Recession Low-income economies Recession 15

  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. 16

  17. Features of Recessions and Recoveries Depend on the Type of Recession… Recoveries Recessions 17

  18. Policies Help Shorten Recessions… Fiscal Stimulus is Effective in Financial Crises… Probability of remaining in a recession beyond a certain number of quarters 18

  19. In the Caribbean, high public debt/GDP ratios have weakened growth and narrowed the fiscal space Growth has been weaker in countries with higher debt levels... ... where fiscal space remains constrained. Change in Primary Deficit and Primary Expenditure Growth, 2010 Public Debt Burden and Real GDP Growth 19

  20. Why did the crisis happen? • Market discipline and regulations failed to keep up with innovation and leverage build up • Macroeconomic policies did not respond to increase in systemic risk • Leadership needed at the international level to detect and respond to risks 20

  21. What can be done to foster the recovery?: A consistent policy framework • Accommodative monetary policy and continued support for banks to support credit and demand. • Repair and reform financial systems. • Medium-term fiscal consolidation plans, including to build credibility and new room for policy maneuver. • Structural reforms and exchange rate flexibility to boost domestic demand in key EM. • Employment promotion and protect the most vulnerable. If recovery threatens to stall: (i) further monetary easing; (ii) in countries with fiscal room, allowing automatic stabilizers to play and postponing some consolidation. 21

  22. Monetary policy needs to remain accommodative, but there are limits to its effectiveness (as long rates are very low) Change in Long-Term Bond Yield, 2010 1/ (basis points) IRL ISR FIN ITA JPN BEL CZE PRT AUS AUT ESP NZL SWE USA NLD SGP SVN FRA SVK CAN DEU GBR GRC KOR HKG TWN NOR DNK 1/ AUS: Australia; AUT: Austria; BEL: Belgium; CAN: Canada; CZE: Czech Republic; DNK: Denmark; FIN: Finland; FRA: France; DEU: Germany; GRC: Greece; HKG: Hong Kong SAR; ISL: Iceland; IRL: Ireland; ISR: Israel; ITA: Italy; JPN: Japan; KOR: Korea; NLD: Netherlands; NZL: New Zealand; NOR: Norway; PRT: Portugal; SGP: Singapore; SVK: Slovak Republic; SVN: Slovenia; ESP: Spain; SWE: Sweden; TWN: Taiwan Province of China; GBR: United Kingdom; USA: United States. 22

  23. Financial sector repair and reformneed to accelerate • Recapitalize/resolve banks • Repair markets for securitized assets • Re-establish market discipline • Implement regulatory reform with a broader and more global view (broaden the regulatory perimeter and foster cross-border coordination among regulators) 23

  24. Medium-term fiscal plans are urgently needed Projected Change in Cyclically Adjusted Primary Balances (percent of potential GDP) Source: FAD staff estimates. 1/ In percent of GDP; distance from blue bar reflects required additional fiscal adjustment relative to 2010-13; adjustment to be sustained between 2020–30 to reduce public debt to prudent levels. 2/ Structural primary balance. 3/ Excluding financial sector support recorded above the line. 24

  25. Dealing with inflow surges: Exchange rate flexibility and capital controls • Fiscal and monetary stimulus policies are leading to capital inflow surges in emerging economies • Macro and prudential policies can help deal with the downsides of inflow surges (appreciation and inflation) • Macro policy space (especially exchange rate) must be exhausted before imposing capital controls • Capital controls and prudential measures should target specific risks • Prudential measures when flows intermediated through the regulated financial institutions • Capital controls when flows by-pass regulated financial institutions 25

  26. Foster employment and protect the most vulnerable ILO/IMF collaboration (Oslo Conference 9/2010) • The crisis will not be over until unemployment falls • Growth is essential for employment, but it is not enough • Job creation must be a priority • Specific policies are needed to protect the poor and the vulnerable (social protection floor) • Programs to subsidize short-term work and on-the-job training • Unemployment benefits • Job subsidies 26

  27. Over the medium term, what are the main lessons for policy makers on the macroeconomic level? • Monetary policy should respond to the buildup of systemic risk (focus on macro-financial stability) • Fiscal policy should be put on a stronger footing in good times (to open up fiscal space for countercyclical fiscal stimulus in bad times) • While international capital flows are on the whole beneficial, global imbalances have to be addressed 27

  28. The world is recovering from the great recession, but huge challenges remain ✓ Unemployment ✓ Fiscal sustainability ✓ Sources of growth ✓ Financial sector reform ✓ Capital flows to emerging markets 28

  29. As the Caribbean recovers from the great recession, it faces significant challenges going forward ✓ • Promoting growth • Energy and infrastructure • Human capital • Competitiveness • Diversification ✓ • Fiscal sustainability • Reducing debt-to-GDP ratios • Creating fiscal space to allow for countercyclical policy ✓ • Financial sector • Strengthening regulations, particularly for nonbank FI • Resolving CLICO ✓ Climate change 29

  30. Growth is projected to be lower than in the past Caribbean: Real GDP Growth 1/ (annual percentage change) 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. 30

  31. Medium-term fiscal plans are urgently needed Caribbean: Projected Change in Cyclically Adjusted Primary Balances (percent of potential GDP) Source: WHD staff estimates. 31

  32. Financial Sector • Strengthening the financial sector requires • Upgrading the legislative and supervisory framework for • Commercial banks • Nonbank financial institutions • Intensifying monitoring and on-site inspections, and more frequent reporting • Consolidated supervision of conglomerates • Agreements and closer collaboration for cross-border supervision • Urgent resolution of CLICO • A transparent resolution process • Minimize fiscal costs and contingent liabilities 32

  33. Thank You

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