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Crisis: How Did We Get Here? Where Are We Headed?

Susan Schadler St. Antony’s College Oxford Canadian Association of Insolvency and Restructuring Professionals August 20, 2009. Crisis: How Did We Get Here? Where Are We Headed?. Questions. Where were we pre-crisis? What happened? Why so unexpected? Where to from here?.

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Crisis: How Did We Get Here? Where Are We Headed?

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  1. Susan Schadler St. Antony’s College Oxford Canadian Association of Insolvency and Restructuring Professionals August 20, 2009 Crisis: How Did We Get Here? Where Are We Headed?

  2. Questions • Where were we pre-crisis? • What happened? • Why so unexpected? • Where to from here?

  3. Where were we pre-crisis I:The Great Moderation • Strong and steady output growth • Low unemployment • Low inflation

  4. World Real Output Growth (1970-2009) Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  5. Unemployment Rate: 1980 – 2010 Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  6. Consumer Price Inflation (1970-2009) Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  7. Just how confident were economists? “If you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: it will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.” Paul Krugman, Slate Magazine, 1997

  8. Where were we pre-crisis II:The Bubble • New channels for household borrowing • US consumers support world growth • House prices sky rocket

  9. Household Debt 1960 – 2008(in percent of gross disposable income) Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  10. The powerful US consumer(US personal consumption and saving)

  11. House Price Bubble: Ratio of House Prices to Income Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  12. Were economists concerned? “Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications. Alan Greenspan, Statement before Joint Economic Committee, June 2005

  13. What Happened?The virtuous circle became a vicious circle • House prices level off, fall • US consumer starts to save • Equity prices level off, fall • Major financial centers under strain • September 2008—turmoil in major institutions • Market panic • Demand collapses • Global recession

  14. World Real Output Growth (1970-2009) Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  15. Unemployment Rate: 1980 – 2010 Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  16. Consumer Price Inflation (1970-2009) Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  17. Why so unexpected?

  18. The Perfect Storm • Central Banks too narrowly focused • Global savings glut pushed to “safe” haven • Financial deregulation ran amok

  19. Weaknesses of inflation-targeting • Surplus labor in new emerging markets holds down goods inflation • Easy money vents in commodity, property prices (low weights in CPI), equity prices • Inflation targeters look the other way

  20. Global Imbalances: Gaps between domestic investment and domestic saving, 1997 – 2009(in percent of global GDP) Source: International Monetary Fund, World Economic Outlook: Crisis and Recovery, April 2009.

  21. Financial deregulation meets the Great Moderation • Growth of activity out of regulatory control • Financial sector leverage soars • Securitized instruments increasingly complex • Interlocked web of holders

  22. Canada: A softer hit, but questions abound • Relatively strong financial regulation • Low government debt, good monetary policy • But US-Canada links, commodity price falls drive fall-out from the crisis

  23. Where to from here?

  24. Three policy challenges • Immediate stimulus -Monetary has reached its limits -Fiscal picks up the burden—or can it? • Financial regulatory reform -Recapitalize/deleverage -Simplify, standardize, downsize -Consumer financial protection laws • Curb global imbalances -End exchange rate manipulation -Stop large reserve accumulation

  25. Recovery—three scenarios Geithner/Orszag: V-shaped Krugman: lost decade Johnson: setting up for the big bubble

  26. Geithner/Orszag V-shaped Scenario

  27. What could lead a recovery? Exports? Consumption? Investment? Government

  28. What could destroy a recovery? • Failure to exit stimulus successfully • Failure to address regulatory challenges • Failure to address global imbalances

  29. And now for questions...

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