29 - Global Macroeconomics and Financial Crises: Capital...

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Unformatted text preview: Global Macroeconomics and Financial Crises: Capital Flows, Financial Crashes and Global Imbalances Pierre-Olivier Gourinchas (UC Berkeley) A lecture for Econ196, Topics in Economics Research, February 23, 2010 1 / 62 Introduction: what is modern macroeconomics about? • Focus on aggregate phenomena • e.g. Aggregate output, unemployment, inflation, interest rates, trade balance... • Emphasis on dynamic stochastic general equilibrium • Many, often complex, interactions between variables of interest. This can lead to the amplification, or nullification of partial equilibrium effects (Think of giving $1,000,000 in cash to someone, or to everyone). • Many sources of uncertainty: • Genuine and well-identified sources of randomness (weather, natural disasters); • But uncertainty also about policy actions (“Will the Fed increase interest rates at the next FOMC meeting?”) or about the actions of other economic actors (“Will the crisis lead U.S. households to reduce their demand for durable goods?”) • Dynamic dimension is especially important. • Expectations about future payoffs impacts asset values today. • Represent the system in an impulse-propagation framework. 2 / 62 Is empirical validation possible? • Unlike applied micro, no access to “natural experiments,” “randomized evaluations,” or “lab evidence”: No one is willing to lend us a few countries to run randomized evaluations! • Empirical evidence relies on: the postwar period, national statistical agencies have collected detailed records on aggregate economic activity (national income accounts). • Using well-established models of microeconomic behavior, properly calibrated using available applied micro evidence (e.g. measured elasticity of the labor supply, or coefficient of relative risk aversion...) and properly aggregated to match the statistical pattern of aggregate variables. • Establishing proper causal inference is necessarily more • Historical record on aggregate variables. Starting in earnest in difficult (and the object of fiercely fought academic battles). Think about the discussions about the effectiveness of Obama’s fiscal stimulus package. • The financial crisis is drawing sharp contours between the theories that succeed and those that fail. 3 / 62 The central questions of global macroeconomics • Positive issues: • The transmission of shocks (productivity, policy, expectations....) • The implications of globalization (externalities, coordination of policies) • Normative issues: • What is the best policy (monetary and fiscal, exchange rate...) to achieve a desired macroeconomic outcome? • What is the best set of institutions (regulation, central banks, fiscal) to achieve economic efficiency? 4 / 62 More narrowly, tonight we’ll focus on “Global Imbalances” • Global Imbalances: A potentially dangerous pattern of current accounts • Last week, you learned with Lemin how to think about a country’s current account deficit/surplus (over time, across countries) • Today, we explore some new perspectives on capital flows: 1 Is there a special role for the United States? • The structure of the U.S. Net International Investment Position and valuation effects • Is there an exorbitant privilege? • What about an exorbitant duty? 2 3 Does the theory do a good job explaining where capital flows? What is the link between global imbalances and the financial crisis, if any? • What is the source of global imbalances? • What is the source of global financial instability? 5 / 62 Global Imbalances: a Bird’s Eyes View % of World GDP 1.5% Asian Crisis 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% 1990 Financial Crisis 1992 U.S. 1994 1996 1998 2000 2002 2004 2006 2008 China Europe & Japan Oil Producers Emerging Asia ex-China Figure: Global Imbalances. Current account as a ratio to world GDP. 6 / 62 Summary from last week • intertemporal approach ˜ CA = Yt − Yt CA responds to temporary shocks, not permanent ones. • capital flows and economic growth • capital should flow towards countries further away from steady state (South runs CA deficits) • capital should flow towards countries with better growth prospects (high TFP growth countries should run CA deficits). 7 / 62 US Net Foreign Asset Position (percent of output) 20 10 0 -10 -20 -30 -40 -50 -60 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 NA/GDP cumCA Figure: Cumulated Current Account and Net Foreign Assets (% of GDP).). Source: Gourinchas, Rey & Govillot (2010) 8 / 62 What is missing? • Recall that derivations assume that countries face a constant risk free rate of return r . • Perhaps a good characterization when countries could only borrow/invest in short term relatively riskless securities, but not a good characterization nowadays. • What is missing is the possibility to make capital gains/losses on foreign assets (valuation effects). • These ‘valuation effects’ are absent from the balance of payment statistics [Why?] In other words, the current account may not reflect accurately the change in external wealth of a country. Bt +1 − Bt = NXt + rt Bt = NXt + NFPt + (rt Bt − NFPt ) = CAt + (rt Bt − NFPt ) 9 / 62 The ‘Exorbitant Privilege’ of the United States The US plays a very special role in the international monetary system: • The US income balance remained positive, despite the US negative external worth (i.e. the U.S. earns interest on its debt!) • This is also true of total returns (i.e. interest + capital gains) • On average about 2.44% in real terms over the whole sample. (return on assets: 5.76%, on liabilities: 3.31%) • Since the end of Bretton Woods, excess returns increased: 3.11% in real terms (6.21% assets, 3.11% liabilities) 10 / 62 US Gross External Assets (percent of output) 140 120 100 80 60 40 20 0 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Gold Non Gold Debt Direct Investment Equity Source: Gourinchas, Rey & Govillot (2010) 11 / 62 US Gross External Liabilities (percent of output) 140 120 100 80 60 40 20 0 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Other Government Debt Corporate Debt Direct Investment Equity Source: Gourinchas, Rey & Govillot (2010) 12 / 62 US Gross Real External Returns average returns ra − rl ra rl ra − rl ra rl ra − rl ra rl 1952:1-2009:4 2.69% 5.84% 3.16% 1.49% 4.91% 3.42% 2.44% 5.76% 3.31% 1952:1-1972:4 1973:1-2009:4 (a) : Valuations 1.30% 3.47% 5.04% 6.30% 3.74% 2.83% (b ) : Financial Flows 1.25% 1.62% 4.71% 5.02% 3.46% 3.40% (c ) : Mixed 3.11% 1.28% 4.96% 6.21% 3.68% 3.11% Table: Panel (a): “Other changes” allocated to valuations; Panel (b): to financial flows; Panel (c): to valuations, except for debt assets and liabilities. r a refers to gross assets, r l to gross liabilities. Annualized quarterly real returns. 13 / 62 Reserve Accumulation 700 600 500 400 300 200 100 0 ‐100 1996 1998 2000 2002 2004 2006 2008 Africa Western Hemisphere Middle East Developing Asia Figure: Growth in Official Foreign Exchange Reserves. Annual change, billions of US dollar.Source: IMF 14 / 62 US Net Foreign Asset Position (percent of output) 20 15 10 5 0 -5 -10 -15 -20 -25 -30 -35 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Source: Gourinchas, Rey and Govillot (2010) 15 / 62 ‘Exorbitant Duty’ • During latest crisis, US net foreign asset position deteriorated massively • Between 2007:4 and 2009:1, NA drops from USD -1.6tr to USD -4.29tr, a decline of USD 2.7tr • Over same period, cumulated current account represents -809bn, • Valuation loss of USD 1.9tr, or about 13.4% of US GDP, 16 / 62 ‘Exorbitant Duty’ • Worsening of US net foreign asset position occurs largely through a valuation loss: risky assets collapse, while US government debt increases in value. • This valuation loss transfers wealth from the US to the rest of the world. • US provides a transfer at times when the marginal utility of consumption is high. • Can interpret the ‘exorbitant duty’ as an insurance payment and the ‘exorbitant privilege’ as the corresponding insurance premium. 17 / 62 A Simple Model of Insurance Provision • 2 countries, Home (US) and Foreign (∗), equal size 1/2. • Endowment economy: yt , yt∗ . Global output yt iid. ¯ • Representative household with CRRA preferences: Et ∞ s =t β t ct1−σ / (1 − σ ), • US has more tolerance for risk: σ < σ ∗ (interpreted broadly as access to technology to reduce risk) • Markets are complete. 18 / 62 A Simple Model • Ex-ante symmetric equilibrium: σ /σ ∗ 1c 1 + 2 Ey ¯2 c Ey ¯ = y ¯ . Ey ¯ • US ‘insures’ foreign against bad times. • US implements allocation with equity holdings of σ ∗ / (σ + σ ∗ ) > 1/2: leveraged external portfolio • if output is log-linearly distributed with variance σ 2 , autarky riskfree rate is E ln Rtaut = − ln β − σ2 2 σ. 2 • lower autarky interest rate abroad since σ ∗ > σ due to precautionary saving • US runs trade deficit 19 / 62 Risk Sharing with Heterogenous Risk Aversion The figure is drawn under the following assumptions: E y = 1, σ = 2, σ ∗ = 5. ¯ 20 / 62 The special role of the US in the international monetary system • In the 1960’s: US borrowed short and liquid and invested long and illiquid. • Now: US borrows in debt and short term instruments (short term credit and bank loans) and invests in high yield assets (equity and FDI). • As a whole, US provides three different types of services: • liquidity to the rest of the world (US is a World Banker) • equity-financing for risky projects (US is a World Venture Capitalist) • What gives the US these advantages? • depth of domestic financial markets (esp. T-bill) • level of financial development that increases effective appetite for risk • economic size • fiscal stability 21 / 62 • insurance against global shocks (exorbitant duty) External Financial Adjustment (Gourinchas & Rey, JPE 2007) • Start from the External Budget Constraint; • Derive an analog to the intertemporal model that incorporates asset returns adjustments; • write: Bt +1 = Rt +1 Bt + NXt Bt where At Lt : gross foreign asset : gross foreign liabilities gross return on net foreign asset portfolio = At − Lt Rt +1 = µa RtA − µl Rtl +1 +1 Rt +1 : and µx = X /B can be very large (leveraged portfolio). 22 / 62 External Financial Adjustment (Gourinchas & Rey, JPE 2007) • Follow the same steps as before: ∞ Bt =− j =0 Rt−1 ,t +j +1 NXt +j + lim Rt−t1 j Bt +j +1 ,+ j →∞ where Rt ,t +j = Rt .Rt +1 ...Rt +j is the compounded return. • Interpretation? A country can have a large net liability if either: relative to its gross liabilities • This equation can be ‘log-linearized’ into: ∞ • it is expected to have large trade surpluses in the future • it is expected to have a large future returns on its gross assets nxat =− j =1 ρj Et (rt +j + ∆nxt +j ) where nxat ≡ [|µa |. a − |µl |. lt ] + [|µx |. x − |µm |. m ] is a t t t measure of external imbalances and x is a ‘deviation from t trend’ for variable x . 23 / 62 Constructing nxa Figure: Trend and cyclical components for X , M , A, L, United States. dnert-PH W/M w m _ s pe 4.2.0. 200. 400. 600. 800. 010. dnert-PH W/L w l_ sp e 4.2.0. 0. 1. 2. 3. 2. 4. 0. 1. 2. 3. 2. 4. 200. 400. 600. 800. 010. dnert-PH W/A w a_ s pe 4.2.0. 2. 4. dnert-PH W/X wx_ spe 4.2.0. 2. 4. 00 5 9 09 5 8 08 5 7 07 5 6 06 5 5 0 0 59 0 9 58 0 8 57 0 7 56 0 6 5 5 00 5 9 09 5 8 08 5 7 07 5 6 06 5 5 0 0 59 0 9 58 0 8 57 0 7 56 0 6 5 5 24 / 62 External Imbalances, United States, 1952-2004 .3 .2 .1 .0 -.1 -.2 -.3 55 60 65 70 75 80 85 90 95 00 Figure: Measure of External Imbalances for the United States (nxa) (as a fraction of exports). 25 / 62 Financial and Trade channels of external adjustment • Rewrite the previous equation as: +∞ +∞ nxat =− j =1 ρj Et rt +j − j =1 ∆ nxat nx ρj Et ∆nxt +j ≡ r nxat + • Estimate each component using a statistical model to form forecasts of rt +j and ∆nxt +j . 26 / 62 The Financial Adjustment Channel 3. Figure: Decomposition of nxa into a financial and trade channels. 27 / 62 00 59 )stropxe(axn )tciderp(axn 09 58 08 57 )nruter(axn 07 axn 56 06 55 1.- 2.- 3.- 2. 1. 0. Can we use this to forecast the US dollar? .12 .08 .04 .00 -.04 -.08 -.12 1975 1980 1985 1990 1995 2000 1-quarter ahead .06 .04 .02 .00 -.02 -.04 -.06 1975 1980 1985 1990 1995 2000 4-quarter ahead .04 .03 .02 .01 .04 .03 .02 .01 actual fitted sep. reg. fitted .00 -.01 -.02 -.03 -.04 1975 1980 1985 1990 1995 2000 8-quarter ahead .00 -.01 -.02 -.03 1975 1980 1985 1990 1995 2000 12-quarter ahead Figure: Predicted Rate of Depreciation of the US dollar, 1-12 quarters ahead 28 / 62 From the time-series to the cross section The Lucas puzzle • Let’s now turn to the cross-section determinants of capital flows and current accounts • The central idea is that capital should flow to the locations with the highest return. • This provides the basis for the Lucas puzzle: • poor countries have relatively little capital. • hence capital is potentially very productive there (compared to industrial countries with more mature markets). • it follows that capital should flow from the developed ‘North’ to the developing ‘South’ • in practice, we observe that the opposite is true. Capital is flowing upstream! • One possible explanation for the Lucas puzzle: poor countries are also less productive (in Lucas original article, this is because they lack human capital that is a complement to physical capital). 29 / 62 Korea and Madagascar, 1980-2000 Investment (percent of GDP) Output growth per worker (percent p.a.) Output per worker in 2000 (PPP) TFP growth (percent p.a.) TFP in 2000 (percent of U.S.) Korea 32 5.4 $22,022 4.1 41.2 Madagascar 2.8 -1.3 $1,599 -1.5 6.6 30 / 62 From the time-series to the cross section The allocation puzzle (Gourinchas & Jeanne (2009)) • Indeed, modern growth theory tells us that one of the most important difference across countries is productivity [But what exactly is productivity measuring?] • This has major implications for the pattern of capital flows across countries: Countries with high productivity growth have an increasing marginal product of capital. They should attract capital, at the expense of stagnant or declining countries. • In practice, the pattern of capital flows is exactly the opposite of that predicted by the theory: capital flows out of Korea and into Madagascar. 31 / 62 Korea and Madagascar, 1980-2000 Investment (percent of GDP) Output growth per worker (percent p.a.) Output per worker in 2000 (PPP) TFP growth (percent p.a.) TFP in 2000 (percent of U.S.) Net capital inflows (% of GDP) Korea 32 5.4 $22,022 4.1 41.2 -0.5 Madagascar 2.8 -1.3 $1,599 -1.5 6.6 5.7 32 / 62 The allocation puzzle (Gourinchas & Jeanne (2009) 15 MOZ COG Capital Inflows (percent of GDP) −5 0 5 10 TZA MLI SEN MWI NER MDG CIV BOL HND LKA CRI BEN PER JAM NPL TUN CHL GHA CMR GTM ECU PRY MAR DOM HTI UGA PAKTHA JOR PNG KEN ISR ARG MUS MEX PAN COL FJI PHL BRA IDN URY IND BGD MYS SLVETH TUR EGY TTO AGO NGA VEN BWA SGP HKG TWN ZAF IRN GAB SYR TGO RWA CYP KOR CHN −10 −4 −2 0 2 Productivity Growth (%) 4 6 Figure: Capital inflows against productivity growth 33 / 62 A small open economy ‘Ramsey’ model • Preferences: • Population growth, n: • Technology: • Long run productivity growth: • Capital wedge τ : Ut = ∞ s s =0 β Nt +s u (ct +s ) Nt = N 0 n t Yt = Ktα (At Nt )(1−α) At +1 /At = gt +1 → g ∗ (1 − τ ) Rt • Budget constraint (w wage, z rebate, x = X /N ) nkt +1 + R ∗ dt = (1 − τ ) Rt kt + ndt +1 + wt + zt − ct 34 / 62 Equilibrium under financial integration • Returns (1 − τ ) Rt = R ∗ • Steady state capital stock (efficient units: x = X /A/N ) ˜ ˜ ˜ kt +1 = k ∗ ≡ α R ∗ / (1 − τ ) + δ − 1 1/1−α • Consumption (smoothing), assuming u (c ) = c 1−γ /(1 − γ )) ct = (β R ∗ )−1/γ ct +1 • Initial consumption: (again, permanent income) c0 = [R ∗ − ng ∗ ] (k0 − d0 ) + 1 − ng ∗ R∗ ∞ s =0 n R∗ s (ws + zs ) 35 / 62 Modeling productivity catch-up Define πt = At / (A0 g ∗t ) − 1, relative productivity. • π0 = 0 • limt →∞ πt = π : long run productivity catch-up • π = A∗ /A0 − 1: full productivity catch-up 0 • π = 0: no productivity change relative to the world frontier • π < 0: long run productivity divergence • πt = π for t ≥ T : no catch-up after time T . 36 / 62 Net capital flows accounting Natural measure of capital flows: DT − D0 ∆D = Y0 Y0 ˜ Proposition: Given an initial capital stock k0 , relative productivity ∞ ˜ process {πt }t =1 and steady state capital k ∗ , the ratio of cumulated capital flows to initial output is given by: ∆D Y0 = ˜ ˜ k ∗ − k0 ∗ T (g n) y0 ˜ w +z ˜˜ ˜ +π k ∗ + R∗ T t =0 ng ∗ R∗ t (1 − πt /π ) (g ∗ n) y0 ˜ T 37 / 62 capital flow accounting: interpretation • Capital Scarcity • Investment • Saving ˜ +˜ π wy0 z ˜ T t =0 ˜ ˜ (ng ∗ )T k ∗ − k0 /y0 ˜ ˜˜ π k ∗ /y0 (ng ∗ )T ng ∗ R∗ t ∗T (1 − πt /π ) (ng ∗) R • there is also a component reflecting initial debt... 38 / 62 Allocation Puzzle 2 TGO CIV NPL THA Actual Capital Inflows 0 1 JOR RWA CHL SEN BFA PAK ECU AGO MLI PER BEN KEN MWI BOL ISR MYS HND TZA NER TUN CYP IDN CRI PRY COL DOM GHA ARG LKA FJI MOZ MEX GTMUGA MDG TUR IND CMR COG PHL MAR PNG ETH PAN MUS BGD HTI IRN SLVTTO BRA NGA URY GABSYR JAM EGY ZAF VEN HKG CHN KOR −1 TWN BWA −2 SGP −20 −10 0 Predicted Capital Inflows 10 20 Figure: Actual and Predicted Cumulated Capital Flows. Sample of 68 developing countries 39 / 62 The allocation puzzle: potential explanations The allocation puzzle is a saving puzzle: rapidly growing countries invest a lot. Yet they save even more! • Demographics and aging: countries with rapidly aging population (Japan) or rapid declines in fertility rates (China) may need to save a lot • Mercantilism: some countries may try to maintain an artificially depreciated currency as a growth engine (China?). This requires the accumulation of vast foreign exchange reserves by the monetary authorities to offset the appreciating pressures resulting from capital inflows and trade surpluses. • financial underdevelopment: many developing countries have low levels of financial development [How would you define/measure financial development?]. Lack of financial sophistication implies more reliance on saving (lower leverage, less borrowing), and more accumulation of savings to offset possible shocks to the economy (precautionary saving). 40 / 62 Global Imbalances: Menace or Innocent Bystander? % of World GDP 1.5% Asian Crisis 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% 1990 Financial Crisis 1992 U.S. 1994 1996 1998 2000 2002 2004 2006 2008 China Europe & Japan Oil Producers Emerging Asia ex-China Figure: Current Account as percent of World GDP) 41 / 62 Quotes I • Hank Paulson, U.S. Secretary of the Treasury (FT, Jan 2, 2009) Global economic imbalances helped foster the credit crisis by pushing down interest rates and driving investors to riskier assets • Jean-Claude Trichet, President of the ECB (Apr. 4 2009) Generally, the macro root causes of the financial crisis can be associated with two measurable developments: low risk premia and the accumulation of global imbalances. • Richard Portes, London Business School and CEPR (January 2009) I argue that global macroeconomic imbalances are the underlying cause of the crisis. 42 / 62 Quotes II • Ricardo Caballero, vox-EU (Jan. 23, 2009) There is an emerging consensus on the causes of the crisis [...]: uncontrolled global imbalances, unscrupulous lenders, and an insatiable Wall Street, all of them lubricated by an ever-expansionary Federal Reserve.[...] I do not share this consensus view and its policy prescriptions. • Mike Dooley, vox-EU (Mar. 21, 2009) Three important misconceptions could lead to a disastrous reform agenda: That the crisis was caused by current account imbalances, particularly by net flows of savings from emerging markets to the US. That the crisis was caused by easy monetary policy in the US. That the crisis was caused by financial innovation. • Olivier Blanchard, Chief Economist, IMF (Jun. 18 2009) As if to prove the sceptics right, the crisis itself was not triggered by global imbalances. 43 / 62 The View Before the Crisis Global Imbalances create vulnerabilities: • Increased dependence on foreign capital; • Risk of ‘sudden stop’; • Would provoke sharp increase in US interest rates; collapse of the dollar • Investment & private consumption would collapse, contracting the US and world economy Problem: global imbalances not even remotely the trigger of the crisis! • Could global imbalances have contributed through other channels? 44 / 62 A model to understand global imbalances • Asymmetry between economic and financial development (Caballero, Farhi & Gourinchas, 2008 AER) • Basic structure: regions of the world are heterogenous along two dimensions: growth (g ) and financial development (δ ). • US (U ) has high growth (g ) and high level of financial development (δ ) levels of financial development (δ R < δ ) • Japan or Europe (E ) have high levels of financial development (δ E = δ )but low growth prospects (g E < g ). • Fundamental asymmetry in financial development and growth • Emerging markets (R ) have high growth (g R > g ) but low prospects. 45 / 62 Closed economy • Consider first each country/region in isolation (autarky). • Output each period Xt is exogenously given (think of a tree producing Xt fruits at time t ). • Consumption is a constant fraction of financial wealth: Ct = θWt ‘log’ preferences) • Households can buy shares of the tree. Financial development is captured by the fact that only a fraction δ of the fruits of the trees can be paid as dividend to the owner of the tree. The rest is paid to the ‘managers’ of the tree, to the government in taxes, is looted away, etc.... • the value of the tree Vt and financial wealth Wt must satisfy: rt ˙ Wt Wt ˙ δ Xt + Vt Vt = rt Wt − Ct + (1 − δ )Xt = = Vt rt = ra = g + δθ 46 / 62 • Combine the equations to solve for the risk free rate rt : The Metzler Diagram r Metzler Diagram W X = (Demand) 1−δ g + θ −r ra (Supply) V X = δ r −g W/X , V /X Global Imbalances March 2007 – p. 12/48 47 / 62 Open economy • Consider now a small open economy • Capital flows will be controlled by the difference between the autarky interest rate and the world interest rate: • Financially underdeveloped countries have low autarky interest rates. They will export capital • Financially developed countries have high autarky interest rates. They will import capital • Capital will flow from R to U • World interest rates decline as emerging economies integrate financially. Low interest rates reflect a global asset scarcity. 48 / 62 Two-Country Metzler Diagram Global Equilibrium r W/X (World) r W/X (US) g+dq r (world) -CA/X/g V/X (World) V/X (US) W/X, V/X W/X, V/X BOK Annual Conference June, 2007 – p. 6/9 49 / 62 L and U.S. INTEREST R Rates World OW REAL Real Interest ATES, 2000-2009 3 50 / 62 Global imbalances and financial fragility • Global Imbalances may be an ‘equilibrium’ phenomenon; • Implies large build-up in external debt and increased financial vulnerability; • In the extreme, it can create conditions for rational bubbles to emerge. • What is a rational bubble? An asset, or the component of an ˙ asset whose price evolves according to Et B = rt Bt i.e. it is expected to pay the prevailing interest rate, regardless of its fundamental value. [Why is it rational?] • A bubble can emerge when the economy is dynamically inefficient, i.e. when the equilibrium interest rate is too low compared to the growth rate of the economy. • Why can a bubble emerge? Because it ‘endogenously’ increases the asset supply to the world economy. In a well-defined sense, it solves the problem that the world economy faces. 51 / 62 STANDARDIZED INDEX 0.5 1.5 2.5 3.5 4.5 -1.5 Mar-85 Mar-86 Mar-87 Mar-88 Mar-89 Mar-90 Mar-91 Mar-92 Mar-93 Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Nikkei NASDAQ GSCI Real Estate Emerging Markets -0.5 The Conservation of the Bubble Bubbles (Standardized Dollar Prices) 52 / 62 U.S. House Prices (Case Shiller Index) 195 185 175 165 155 145 135 125 115 105 95 85 75 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Subprime Crisis Asian Crisis S&P/Case Shiller Composite-10 Price Index (CPI deflated) 53 / 62 Commercial paper outstanding, billions USD. billions USD 1400 1200 Lehman Brothers 1000 800 Subprime Crisis 600 400 2003 2004 2005 2006 2007 2008 Asset Backed Commercial Paper Non-ABCP 54 / 62 TED spread decomposed as Libor-OIS and OIS-Treasury percent 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 Jan-07 Subprime Crisis Lehman Brothers Jul-07 Jan-08 Jul-08 LIBOR-OIS Jan-09 T-Bill-OIS Jul-09 Jan-10 55 / 62 A model of financial fragility and global imbalances • Consumption: Ct = θ Wt as before • Preferences over two goods: numeraire good (X ) and commodity (Z ) Ct = CX ,t (σ −1)/σ + α σ CZ , t 1 (σ −1)/σ σ /(σ −1) • Asset Supply: • Good Asset, Vt : Xt trees producing each one unit of X . A fraction δ of each tree is capitalized. • Inventories, pt It : pt /pt ≤ rt . ˙ ˙ with equality when It or It > 0 (Hotelling mechanism). ˙ • Rational Bubble, Bt : Bt = rt Bt • Goods Market: Xt grows at rate g ; Z constant. 56 / 62 The Case σ = 1 (unit elasticity) θδ • Global asset scarcity: r ref = 1+α < g • Bubbles equilibrium: qt rt Bt ≡ t →∞ t →∞ ∼ ∼ pt α = ≡q ¯ Xt Z g 1+α g − r ref Xt θg • Bubbleless equilibrium (Inventories) ˙ It = Z − α/qt qt = (rt − g ) qt ˙ δ + α − qt (Z − gIt ) rt = θ ∼g t →∞ 1+α 1+α pt It ∼ g − r ref Xt t →∞ θ g 57 / 62 The ‘Phase Diagram’ The Model with Inventories. qt A ˙ q=0 ¯ q B1 C ˙ I=0 B2 I0 Caballero, Farhi & Gourinchas () ¯ I Z /g It 19 / 40 Figure: The Model FinancialInventories when σ = 1.Feb. 24, 2009 with Crash... 58 / 62 TThe impact of of the crisis crisis (Phase I). he first phase the subprime qt qt0 B ˙ q=0 ¯ q A C ˙ I=0 It0 = 0 Caballero, Farhi & Gourinchas () ¯ I Financial Crash... Z /g It Feb. 24, 2009 20 / 40 59 / 62 TThe Impact of the Growth Slowdownref < g II). he second phase of the crisis: g < r (Phase ˆ qt qt0 ˙ q=0 B D qt1 ¯ q A C ˙ I=0 E It0 = 0 Caballero, Farhi & Gourinchas () Financial Crash... It1 ¯ I It Feb. 24, 2009 30 / 40 60 / 62 Price of West Texas Intermediate (WTI), 2008 USD 170 150 Subprime Crisis 150 130 110 90 70 50 30 10 1970 130 110 90 70 50 30 Jan-07 Jul-07 Jan-08 Jul-08 Lehman Brothers Asian Crisis Subprime Crisis 1975 1980 1985 1990 1995 2000 2005 61 / 62 Global imbalances and the financial crisis of 2007– Caballero, Farhi and Gourinchas (Brookings, 2009) • We don’t have a theory of the location of the bubble. It can locate itself in many segments of our economic systems; • In 2001-2007, it attached itself (but not exclusively) to the U.S. housing and credit markets. • In the first phase of the crisis (June 07-June 08), the collapse of the bubble exacerbated global asset scarcity, which in turn triggered speculative activity on commodity markets. • Once again, this was a way for a stretched world economic system to increase endogenously global asset supply • In the second phase of the crisis (june 08-...) global growth conditions deteriorated, removing the global asset scarcity and destroying the commodity bubble. • This suggests that, once the crisis is over, the conditions for global asset scarcity will resume and with them, the financial instability..... 62 / 62 ...
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29 - Global Macroeconomics and Financial Crises: Capital...

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