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This Time is Different Syndrome Carmen Reinhart and Kenneth Rogoff

This Time is Different Syndrome Carmen Reinhart and Kenneth Rogoff. Belief that financial crisis is something that happens to other people in other countries at other times. We do things better We’re smarter We’ve learned from past mistakes Arrogance, and then the shock–the Minsky moment

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This Time is Different Syndrome Carmen Reinhart and Kenneth Rogoff

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  1. This Time is Different SyndromeCarmenReinhart and Kenneth Rogoff • Belief that financial crisis is something that happens to other people in other countries at other times. • We do things better • We’re smarter • We’ve learned from past mistakes • Arrogance, and then the shock–the Minsky moment • Short-term bias of politicians: • borrow now...let the future pay • Hidden debt, e.g., implicit guarantees of GSEs

  2. This Time Ain’t Different Prelude to crises: buildup of debt Public and private Foreign and domestic Run up of debts accelerates as crisis nears. Flavors of crisis Sovereign debt crises Serial default is a widespread phenomenon across emerging markets and several advanced economies. Once debt is restructured, countries quick to releverage. Inflation crises...another way to “default” Banking crises...coincide or precede sovereign debt crises Currency crises

  3. But Reinhart & Rogoff remind us: sovereign default is an old story, including among advanced countries –This Time is Different, updated in “From Financial Crash to Debt Crisis,” 2010 Sovereign External Debt: 1800-2009 Percent of Countries in Default or Restructuring 1930s 50%- 1870s 1830s 1980s

  4. U.S. Debt

  5. This Time Ain’t Different Reinhart and Rogoff • “Excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom.” • “Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced.” • Highly leveraged economies “can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear, and a crisis hits.“ • Eight centuries of experience suggests this time is not different.

  6. Was it a surprise? • Certainly some new elements • Originate and distribute model • Financial derivatives • Shadow banking system • But the basic mechanism is always the same (described by Kindleberger and Minsky)

  7. Was it a surprise? • Policymakers did not do anything because the operated under the assumption that markets know best • I made a mistake in presuming that the self-interest of organizations, specifically banks and others, were such is that they were best capable of protecting their own shareholders and their equity in the firms. It shocked me. I still do not fuIly understand why it happened… • They also thought that cleaning up the mess was easy and cheap

  8. Was it a surprise? • Academic economists where seduced by policymakers • …we were in sync with policymakers… lured by ideological notions derived from Ayn Rand novels rather than economic theory. And we let their... rhetoric set the agenda for our thinking and … for our policy advice.Acemoglu (2008) • Incentives also matter, both in business schools and econ departments (Eichengreen, 2008)

  9. This Time Ain’t Different Consequences of banking crises • Real GDP down – Unemployment up • Government revenue down • Government bailout of banks • Government debt/GDP UP • Prolonged slump • Deleveraging • Zero lower bound  Monetary policy weakened

  10. Discrepanciesacross estimates of bail-out costs are large and in, some cases, staggering Reinhart and Rogoff

  11. Thus, the true legacy of financial crises is more government debt… Reinhart and Rogoff

  12. A “Second Great Contraction”Comparing Current Downturn with 1930s Before • Monetary expansion • Stock market exuberance • Huge household debt • Overextended banking system • Real estate bubble After • 1930s: Policy mistakes  Great Depression • Now: Aggressive intervention  No Depression • Europe in austerity funk – “Gold standard mentality”

  13. After 3 years, the U.S. in 2011 finally achieved its pre-recession level of GDP Trend Slump Obama Inauguration End of recession

  14. World Industrial Output

  15. World Equity Markets

  16. World Trade

  17. Central Bank Policy

  18. Eichengreen and O’Rourke • “The world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.” • “The good news, of course, is that the policy response is very different. The question now is whether that policy response will work. “

  19. Lessons for Developing Countries • Protect yourself • Avoid appreciations • Accumulate reserves • But they are never enough • Avoid currency and maturity mismatches • Remember that it may be true that a fully open capital account can deliver the goods with a well-regulated financial system • But who has a well-regulated financial system?

  20. Historic Role Reversal:Public finances in Emerging Marketshave become much stronger since 2000 Appendix II: Historic Role Reversal:Public finances in Emerging Marketshave become much stronger since 2000 even while weakening in advanced economies. World Economic Outlook, IMF, April 2012

  21. US debt > big EMsbut < some other advanced countries http://www.marketobservation.com/blogs/media/blogs/Statistics/DebtGDP.jpg

  22. Country creditworthiness is now inter-shuffled “Advanced” countries (Formerly) “Developing” countries AAA Germany, UK Singapore, Hong Kong AA+ US, France AA Belgium Chile AA- Japan China A+ Korea A Malaysia, South Africa A- Brazil, Thailand, Botswana BBB+ Ireland, Italy, Spain BBB- Iceland Colombia, India BB+ Indonesia, Philippines BB Portugal Costa Rica, Jordan B Burkina Faso SD Greece S&P ratings, Feb.2012 updated 8/2012

  23. The fiscal role reversal, Many Emerging Markets countries have, so far this century, achieved: Lower debt levels than advanced economies; improved credit ratings; lower sovereign spreads; and less pro-cyclical fiscal policies.

  24. The historic role reversal Debt levels among rich countries(debt/GDP ratios > 80%) by 2008 reached twice those of emerging markets. Some emerging markets have earned credit ratings higher than some so-called advanced countries. Over the last decade some emerging market countries finally developed countercyclical fiscal policies: They took advantage of the boom years 2003-2007 to run primary budget surpluses and cumulate reserves. By 2007, Latin America had reduced its debt to 33% of GDP, vs. 63 % in the US. And so were able to respond to global recession of 2008-09 . 26

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