Introduction to the Courseand Main Issues in the Global Economy by Nouriel RoubiniStern School of Business, NYUSeptember 2013
International Macroeconomic Policy: Theory and Evidence from Recent Financial Crises • We study macroeconomic developments: growth, unemployment, consumption, investment, inflation, trade balances, exchange rates, etc. • Macroeconomics is an international discipline as most economies are not closed but open to trade in goods, services, labor, capital, technology, information (globalization). • Most countries are small open economies; some (U.S.) are large open economies. The world economy is interdependent and interconnected thanks to globalization
International Macroeconomic Policy • Macroeconomic developments depend on macro policies: • Conventional (the policy rate tool, the money supply) and unconventional monetary policy such as, ZIRP (Zero Interest Rate Policy), QE (Quantitative Easing), CE (credit easing), FG (Forward Guidance), Negative Interest Rates, Liquidity Support of Banks and Non-Banks • Conventional (tax and government spending) and unconventional fiscal policy (bailouts of banks, households, corporations and other state guarantees for economic agents
International Macroeconomic Policy • Macroeconomic developments depend on macro policies: • Exchange rate policies: choice of the exchange rate regime (fixed, flexible, etc.), forex intervention, capital controls • Supervision and regulation of the banks and other financial sector intermediaries (capital regulation, liquidity regulation, macro-prudential supervision, counter-cyclical credit policy) • International economic policies such as coordinated macro policies as well as international bailouts (by the IMF or the “Troika”) of countries or bail-in of countries (coercive restructuring of public and/or external debt)
The nexus between macro news, policy reactions and markets/asset prices • Macro Triangle: macro developments/news, policy reaction, markets and asset prices • Macro developments/news lead to policy reactions • Those policy reactions affect the evolution of the macro variables • Macro news and macro policies affect markets and asset prices (stocks, bonds, currencies, commodities, credit) • Asset prices react to macro news and policy news, not to expected changes. • Asset price changes lead to policy reactions and affect macro variables (through wealth effects and price effects)
Theory and Evidence from Recent Financial Crises • Financial crises have become more frequent and severe in both developed markets (DM) and emerging markets (EM) • Recent developed markets crises • US housing and sub-prime crisis in 2006-2008 • Global Financial Crisis (GFC) of 2008-2009 • Sovereign debt crises and economic crisis in the Eurozone (2010-2013): Greece, Ireland, Portugal, Spain, Italy, Cyprus, Slovenia • Recent emerging market crises: • Mexico (1994), East Asia (1997-98), Russia (1998), Brazil (1999), Turkey and Argentina (2001) • EM mini-crisis in 2013
Nature of Financial Crises • There are many types of financial crises: • Currency crisis when a fixed exchange rate regime collapses or a currency goes into a free fall • Balance of Payments (BoP) or external debt crisis • Sovereign debt crisis • Banking crisis • Corporate debt crisis • Household debt crisis • Broad financial crisis that combines many elements of the above crises
Types of financial crises: liquidity versus solvency crises • Financial Crises can be distinguished into two broad types: • Solvency crises • Liquidity crises • Insolvency: An agent is insolvent when its debt relative to its income is so high that in most states of the world it will not be able to pay back its debt and the interest on it (unsustainable debt) • Illiquidity: An agent is solvent but illiquid when its debt is not unsustainable but it has large amounts of this debt coming to maturity (short term debt) and it is not able to roll it over (liquidity crisis, rollover/run crisis)
Liquidity versus Solvency Crises • Many combinations of liquidity/illiquidity and solvency/insolvency • Illiquidity can lead to insolvency as illiquidity can trigger default • Illiquidity can be resolved via: • Domestic or international lender of last resort support (bailouts) to stop rollover/run crises • Orderly but coercive restructuring (maturity extension) of debts (bail-in of creditors policies) • Insolvency is resolved via: • Orderly debt restructuring before default • Disorderly debt restructuring (default)
Course Structure • Syllabus: http://people.stern.nyu.edu/nroubini/MACRO5.HTM • Textbooks • Reading List: http://pages.stern.nyu.edu/~nroubini/Readingl3.html • Assignments: http://people.stern.nyu.edu/nroubini/ASSIGN01x.HTM • Requirements (assignments, mid-term exam, final exam) • Other online and offline tools for the course
Current Global Economic Outlook and Uncertainties (Known Unknowns) • Former U.S. Defense Secretary spoke during the Iraq War of “known knowns, known unknowns and unknown unknowns”. • Known unknowns are known risk/uncertainty factors that will materialize in the future in one way or another • The world economic is characterized today by many “known unknowns”, for example who will be the next Fed Chairman?
Known Unknowns: Fed Chair Example • Known Known: Larry Summers will not be the next Fed Chairman • Known Unknown: We will get a new Fed Chairman in 2014. Who will he/she be? Yellen, Geithner, Kohn, Ferguson, Fischer or even Bernanke again? • Unknown unknown: One of you or even “Roubini” could become Fed Chair. Almost impossible.
Known Unknown: Fed Tapering and exit from QE? • When will the Fed start tapering QE? • October FOMC meeting • December FOMC meeting • In 2014 • When will the Fed finish tapering and exit QE? • by June 2014 • in the second half of 2014 • in 2015
Known Unknown: Fed Forward Guidance & Exit from Zero Policy Rate • When will the Fed start exiting from Zero Policy Rate (Fed Funds rate)? • In 2014 • In first half of 2015 • In second half of 2015 or late • When will the Fed finish normalizing the policy rate to a neutral level? • One year after starting (as in the 1994-1005 cycle) • Two years after starting (as in the 2004-2006 cycle) • Three years after starting • More than three years after starting
Known Unknown: U.S. Fall Fiscal Fistfights • Three fiscal known unknowns in the fall in the U.S.: • Government shutdown if no agreement on a continued resolution (CR) by October 1st ? • Technical debt default if now agreement on the debt ceiling (October 15- November 15)? • Continuation of the spending sequester or agreement to replace it with something else?
Macro and market implications of these known unknowns • The resolution of these 4 known unknowns (Fed tapering, Fed chair choice, Fed exit from zero rates, U.S. fiscal fights) will affect: • The real economy through demand and confidence (consumer, business) effects • The financial markets and asset prices in the U.S. and globally: bond yields, stock market, credit spreads, U.S. credit rating, U.S. dollar value, commodities, emerging markets.
Current Known Unknowns in the Global Economy • U.S. monetary and fiscal uncertainties • Prospect for growth in developed markets (DM) and emerging markets (EM) • Will DM return to strong growth or will the recovery remain anemic? • Is the recent slowdown in EM cyclical or structural? • Will some EM experience a full crisis and which ones are at risk?
Current Known Unknowns in the Global Economy: Europe • Will the recovery of growth in the Eurozone be robust or weak? • Which government coalition will emerge in Germany and what its policies will be? • Will the Italian government survive beyond 2013? • Political risks in Greece, Spain, Portugal? • German constitutional court decision on the OMT • Will the ECB ease monetary policy this year or stay put? Rate cut or another LTRO?
Current Known Unknowns in the Global Economy: Japan • Will Abenomics work in Japan? • Strong growth and end of deflation or relapse? • Will structural reforms and trade liberalization be implemented? • Effects of the increase in the VAT tax in 2014? • Risk of a public debt crisis in the next few years? • Will the Yen weaken further?
Current Known Unknowns in the Global Economy: China • Will China experience a soft landing or hard landing? • Will China successfully rebalance growth away from too much savings, investment and exports towards private consumption? • Which reforms will be decided at the November Third Plenum of the Central Committee of the CCP?
Current Known Unknowns in the Global Economy: EM • Is the recent slowdown of EM cyclical or structural? What are its causes? • Will financial pressures intensify to the point of a crisis in some EM or will they diminish? • Which EM are most at risk and why? • What policy options are available for these EM at risk? • What are the medium term prospects for the BRICS and other EM?
Current Known Unknowns in the World: Geopolitical Risks • Syria: attack or compromise? • Israel/U.S. versus Iran on nuclear proliferation • Middle East as an arc of instability • Asian territorial issues (as in the case of Japan-China dispute on some islands) • Geo-political implications of the rise of China: “peaceful rise”? • Are we in a G-20 or G-0 world? • Which other unknown unknowns (like 9/11)?
The global economy after the global financial crisis (GFC) • The economic recovery after the GFC was two-speed: • Anemic, sub-par, below trend in DM (US, EZ, UK, Japan): U-shaped • Strong with return to potential or above trend in most EM: V-shaped • Why V-shaped in EM? • Less balance sheet problems of too much private and public debts. Cleanup after EM crises of the 1990s • Higher potential growth (5% in EM vs 1-2% in DM) • More room for policy response
Why U-shaped Recovery in DM? • The 2008-09 crisis was not a plain vanilla recession • It was a recession caused by a financial crisis. And a financial crisis caused initially by too much debt and leverage in the private sector (households, banks and some corporates); and then during the crisis by a surge in public debt and deficits • History and theory suggests that recovery from balance sheet crises is anemic for up to a decade: you need to spend less and save more (dissave less) to reduce debt and leverage over time. Thus, an anemic recovery. • Actually, a double dip recession in some DM (EZ, UK, Japan)
How did we avoid a Great Depression 2.0? • During the GFC (btw the collapse of Lehman and mid-2009) global economic activity was falling at a speed similar to the beginning of the Great Depression • The Great Recession of 2008-09 could have ended up into Great Depression 2.0. • What avoided that? Learning the lessons of the Great Depression and avoiding policy mistakes • Large conventional/unconventional monetary easing • Massive fiscal stimulus for a while • Backstop and bailout of the private sector (financial system, households, corporations)
Side effects of the massive policy response during the GFC • The massive monetary/fiscal/bailout response during the GFC was necessary to avoid another depression • But it has led to lingering problems: • How to exit from ZIRP, QE, CE, FG? • How and how fast to reduce fiscal deficits and debts that may be unsustainable? • How to deal with the moral hazard that bailouts have induced?
Do you want to be Keynesian or Austrian following a financial crisis? • Keynesian approach: provide monetary & fiscal stimulus and bailout the private sector as otherwise the recession can lead to a depression as self-fulfilling panics and runs occur while private demand is collapsing • Austrian approach (“Austerian”): front-load the adjustment/reform and restructure balance sheets and P&Ls. Don’t bailout as you postpone financial and operational restructuring and you cause moral hazard: zombie banks, households, governments • Austrian approach was tried in the 1930s (no monetary/fiscal stimulus and allow banks to collapse) and led to Great Depression. “Liquidate liquidate!” • Bernanke learned the lessons of the Great Depression
Do you want to be Keynesian or Austrian following a financial crisis? • In the short run you want to be Keynesian as you want to avoid panic, animal spirits, runs and illiquidity to lead to a collapse of the private sector. Public demand has to substitute for collapsing private demand. Rescue illiquid but solvent agents. • In the medium-long term you want to be more Austrian and do true economic and financial restructuring as, otherwise, you can zombify the economy and reduce long term growth • Are problems of illiquidity or insolvency?
These debates – Keynesian vs Austrian- are still ongoing today • Growth versus austerity debate • Front load fiscal austerity (as in EZ and UK) or back load it (US, Japan)? • Be very aggressive in monetary easing (US and Japan) or less aggressive (UK, EZ)? • Bailout banks and recapitalize them fast (US) or go slow (EZ, UK)?
Empirical evidence on appropriate policy response • US avoided a double dip recession and is growing at a 2% rate (output above pre-crisis level). Now even Japan is growing robustly • EZ and UK had a double dip recession and are now barely growing (output still below pre-crisis level) • What explains this relative performance? • Relative monetary easing stronger in US/Japan • Front load or back load of fiscal consolidation • Backstopping the financial system and recapitalizing the banks early on to avoid a sever credit crunch
Recent Reversal of DM vs EM Growth Fortunes • In 2010-2012 slow, anemic growth in DM (U-shaped), strong growth in EM (V-shaped) • In 2013: • Signs of stronger growth in DM (US, EZ, UK, Japan) • Sharp slowdown of growth in EM and financial pressures on EM markets
Why growth is recovering in DM? • Deleveraging of private and public sector balance sheets has been ongoing for five years. Closer to a clean-up • New rounds of unconventional monetary policies in the U.S., Japan (QE and FG) and even in the EZ and UK (FG) • Bailouts of banks and sovereigns in the EZ avoided a worse crisis and EZ break-up • The massive monetary stimulus has led to asset reflation (equity, housing, lower bond yields) that boosts confidence and increases demand
Why slowdown of Growth in EM and Financial Pressures? • Strong growth in EM in the last decade (2003-2013) was due to structural factors and cyclical/luck ones • Structural: • 1st generation structural reforms (trade liberalization, openness to FDI, privatizations, opening of the economy) • Sounder monetary and fiscal policy and stronger balance sheets after the EM crises of the 1990s • Cyclical: • China boom (10-11% growth) • Commodity super-cycle (partly because of China) • Super-easy monetary policies in DM after 2009. Search for yield
Why slowdown of Growth in EM and Financial Pressures? • Why slowdown now then? • 2nd generation reforms did not occur (micro ones that increase competition and productivity) • Move away from market oriented policies towards state capitalism • Some laxity in monetary and fiscal policy as liquidity was abundant, interest rates too low and credit excesses • End of luck as: • China is slowing and becoming less resource oriented • The commodity super-cycle is over • However slowly the Fed will taper and exit 0% rates. US bond yields up from 1.6% to 2.9% since May
Which EM will suffer the most? • Some EM have stronger macro, financial and policy fundamentals and some have weaker ones • Weaker ones include countries with large current account deficits, large fiscal deficits, falling growth, rising inflation, socio-political protest and upcoming elections • Weaker group includes: India, Indonesia, Brazil, Turkey, South Africa, Ukraine
Will some EM experience a severe financial crisis? • Compared to the past even the weaker EM have some positives: • Flexible exchange rates rather than fixed ones that could collapse • A war chest of forex reserves to avoid liquidity runs on banks, currencies and governments • Less currency mismatches and liability dollarization • Lower private/public/external deficits and debts: less solvency risk • Better regulated banks and financial systems
Will some EM experience a severe financial crisis? • But the weaker EM have some negative risks • Ugly policy dilemma: • If you tighten monetary policy to avoid currency free fall and inflation, you kill growth and damage banks/corporations. So tight money is not credible. • If you loosen monetary policy to boost growth, there is the risk of an inflationary free fall of the currency and risk that foreigners will not finance your external deficit. If you thus loosen monetary policy you may lose the nominal anchor of the economy and thus cause a free fall • So damned if you do and damned if you don’t!
Medium term optimism for EM in spite of short run pressures • Medium term positive trends in EM: • Urbanization • Industrialization • Population growth • Per capita income growth • Rise of middle classes and consumer society • A larger share of global GDP and growth in EM • High potential growth given by: • Demographic dividend (high population growth) • 2nd generation reforms will boost competition and productivity • Ability to absorb existing and new technologies developed in DM • Technological innovation in some EM (Korea, China, India, etc)
Will the DM recovery soon lift the growth in EM? • Optimistic viewpoint: the strong recovery of DM growth will soon lift – via trade channels – the growth rate of EM (recoupling) • Three reasons to be skeptic: • The recovery of most DM will be anemic. Soft data (PMIs) are strong but hard data (GDP, employment, demand) are weaker • If the DM recovery will be stronger the Fed will exit QE faster and that will hurt the weaker EM while benefitting the stronger ones via trade • If some weak EM were to experience a crisis, global risk will be off & contagion from EM to DM is possible
U.S. growth is still anemic if improving tentatively • U.S. economy still in an anemic recovery and only tentative improvement • Q2 growth 2.5% (1.9% ex inv.); Q3 expected to be 1.5%. 2013: 1.7% below a 2.5-2.75% trend • Latest data on GDP, labor market, consumption, investment, net exports are soft • Unemployment rate falling because of fall in labor force participation rate (discouraged workers) • Still a fiscal drag and fiscal uncertainties • The rise in long rates given taper talk is already crimping growth of interest sensitive sectors (housing, capex) • This is why Fed decided not to taper QE in September • 2014 growth: Consensus: 2.7%. More likely: 2.4%
Eurozone outlook: less tail risks but fundamental problems unresolved • The recovery of the EZ after the GFC was weaker than in the US given weaker policy stimulus • The EZ relapsed in a double dip recession in 2011-2013 • The periphery of the EZ entered a severe financial crisis with serious sovereign risks. Seven countries in trouble and five bailed out (Greece, Ireland, Portugal, Spain, Cyprus) • Problems were initially in the private sector in Spain and Ireland; in the public sector in Greece, Portugal and Italy • Doom loop between the EZ banks and the sovereigns • At the peak of the crisis in summer of 2012 risk of Grexit, EZ break-up, loss of market access by Italy and Spain
EZ tail risks are lower today • EZ tail risks are lower today thanks to: • Draghi’s “whatever it takes” • OMT program • ESM program on top of EFSF and EFSM • Beginning of a banking and fiscal union • Germany realizing that EZ is also a political project • Austerity and reforms supported by bailout funds, both fiscal and monetary (ECB)
Some Positives in the EZ Today • The EZ recession is over (even if 5 members of the periphery still in recession) • A lot of fiscal adjustment is done and less fiscal drag ahead • Troika agreed to back load some austerity • Beginning of structural reforms • Internal devaluation (fall in Unit Labor Costs to increase competitiveness) in some periphery • Fiscal adjustment and reform in exchange of liquidity and bailout funds holding politically. Grand bargain between core and periphery
The Negatives in the EZ • Low potential growth given slow reforms • Recovery after recession will be very weak • Public and private debts are still high and rising. Debt sustainability issue • Loss of competitiveness has not been fully reversed. Improvement in trade balances is cyclical (recession) • Strong euro doesn’t help • Still credit crunch in banks • Still fiscal drag if diminished
The Negatives in the EZ • A monetary union requires a banking, fiscal, economic and political union to be viable in the long run • Some limited progress on the banking union • Austerity fatigue in the periphery and bailout fatigue in the core • Political risks in the periphery are high • The ECB is moving but too little too late; as usual behind the curve. Its forward guidance isn’t strong enough
Abenomics is working so far in Japan but risks remain • Abenomics is working so far: • Deflation ending • Growth picking up • Yen weaker and stock market stronger • Open issues: • Will structural reforms and trade liberalization that increase potential growth be implemented robustly? • What will be the effect of the rise of the consumption tax in 2014-15? • Is the public debt of Japan sustainable in the long run? • How and when to exit QE?
China: Hard landing or soft landing? • Will China experience a soft landing or hard landing? • China’s growth is unbalanced and unsustainable: too much savings, investment and exports; too little private consumption • Will the reforms to be decided at the November Third Plenum of the Central Committee of the CCP strong enough to rebalance growth? • Reforms will be slower than optimal and desirable as leadership is divided • Risk of a harder landing than the consensus expects (7.5% t0 8% growth). Growth may slow down to 7% in 2014 and below 6% by 2015
Major E’s in the global economy: The 2010-2013 period • Economy • Energy and oil prices • Exchange rates and external imbalances • Euro/Eurozone/ECB • Emerging Markets • East as Middle East • East as East Asia • Earnings/Equity markets
Economy (global) during the Global Financial Crisis (GFC) • The US and the global economy experienced in 2008-2009 their worst recession in decades • The housing and mortgage bust led to an economy wide recession in the US as there were spillovers of the housing recession to other sectors of the economy (autos, manufacturing, consumer durables) • The liquidity and credit crunch that started in the sub-prime mortgage market spread to all credit and financial markets as this was not just a sub-prime problem: sub-prime, near prime and prime mortgages, commercial real estate mortgages, credit cards, auto loans, student loans, leveraged loans • Also the US consumers (consumption is 70% of aggregate demand) were shopped-out, saving-less and debt-burdened
Economy (in the GFC) • This was both a liquidity crunch and a credit crunch the driven by serious solvency problems given over-leverage of households, financial institutions and parts of the corporate sector • The myth that the rest of the world could decouple from the US recession was shattered in 2008: there was massive re-coupling first in financial markets and then in the real economy. Recession in most advanced economies (US, Eurozone, Japan); recession or massive growth slowdown in emerging market economies) • The Great Recession of 2008-09 bottomed out in late 2009 when most economies started to recover. But the recovery in DM since then has been anemic, sub-par, below trend, a U-shaped recovery. Stronger in 2014?