Global Imbalances

Ford Ramsey, Claire Huang, and Prof. Yang

What Global Imbalances?

Saving Behavior Investment Behavior

Portfolio Behavior

Global Imbalances in Connection with the Current Financial Crisis

Global imbalances had little to do with the crisis, which was mainly caused by lax financial regulation on the part of the United States.

Global Imbalances were the prime cause for the economic crisis as they depressed interest rates which incentivized investors to make risky investments.

Global imbalances and lax financial regulation in the United States worked in concert to create the current financial crisis.

Evidence and Visual Aids

• There is a sustained increase in the dispersion of current account balances worldwide starting in 1996, with a brief downturn in 2001-02.

• The nature of global imbalances imbalances has changed through time. For instance, Japan was the main counterpart to U.S. deficits during the 1990s, and China took over this role with large surpluses in the early part of the 21st century.

Three Important Economic Periods

• Differences in Perceived Profitability, 1996-2000.

• Declining U.S. Saving, 2001-2004.

• Asset Booms and Busts, 2005-2008.

Savings Rate

Chinese Saving Statistics

• China

– 1981: 20%

– 1988: 30%

– Present: remain at 40%

• GDP rate increased 10% yearly.

http://blogs.cfr.org/setser/files/2009/02/china-saving-and-investment.png

A Brief Summary Rising current account deficits in the United

States particularly, with rising surpluses in China, the Middle East, and other Asian markets.

Significant declines in household savings in the United States with an increase in household savings in developing countries.

An Argument for Positive Feedback Behavior Precipitating Crisis

Rising U.S. deficits and surpluses in Asian countries and the Middle East spawned a savings glut in developing countries. Capital flowed to advanced countries. (primarily the U.S.) This caused interest rates to drop nearly worldwide.

The drop in interest rates led to a boom in housing investment, and less household savings on average as U.S. investors moved to take advantage of the economic situation.

Imbalances fed consumption which fed imbalances, and so a positive feedback loop was initiated.

How Imbalances Affect Crisis Imbalances in savings, investment, and portfolios led to a situation

where real interest rates were driven down and assets increased in price.

With easy sources of capital from surplus nations, and low interest rates, American households and investors were more willing to continue expanding consumption and the housing boom, as well as making riskier decisions in the instruments they used.

All in all, imblances led to a unique combination of low interest rates, low inflation, housing appreciation, lax lending practices, credit expansion, and strong incentive towards high leverage.

Eventually, interest rates in the United States had to adjust as the deficit moved to increasingly large amounts. As various investment instruments adjusted as well, investors found themselves looking at a decrease in asset prices and a simultaneous increase in the real interest rate.

What Can Be Done? The U.S. Government can reign in spending

and lower the deficit, while the Chinese government brings its current account surplus into balance.

Structural changes in Japan and Europe to break out of a low investment situation that relies on exports.

Stimulation of Chinese domestic consumption.

Information Shocks and Macroeconomic Imbalance in the World Economy

A discussion

3/25/10

1.Introduction

• 1.1Definition of the Imbalance of World Economy

• (1)Deficit or Surplus of BOP in a country

• (2)changes of Regional Economy

• (3)Waves of Global Economy

• For the time being, majority of economists and politician focus on the issue at a perspective of macroeconomic imbalance of one nation. That is to say, most of them define the imbalance of World Economy as (1).

3/25/10

1.2Forms of Macroeconomic Imbalance in the World Economy

• (1)Trade Imbalance

• (2)Financial imbalance

• (3)Investment Imbalance

3/25/10

1.3Different interpretation of the reasons for imbalances

• (1)unfair Trade Practices

• (2)decline of Competitiveness

• (3)poor management practices

• (4)old-fashioned labor-relations procedures

• (5)lack of entrepreneurship

• (6)fiscal policies

• (7)monetary policies

• (8)investment cycles

3/25/10

2.The importance of Information Shocks: some cases

• Case 1:Enron nightmare and the burst of .com bubble• --Enron before and after 2001

• -- The world's fifth largest accounting firm Arthur Andersen and the Enron Corporation as a financial audit report, neither Enron audit of false profits, and it has not found its huge debts. This year, in June, Arthur Andersen audit work because of a fraud by the United States Securities and Exchange Commission fined the 7 million US dollars.

• --direct consequences and indirect consequences

• Case 2:East Asian Financial Crisis in 1997

• Case3:Toyta’s recalling and its market share in U.S. and other countries

3/25/10

3.Modelling:Information shock as the reason for imbalances

• 3.1Mothod 1:based on an extensive GNP model• A simple GNP model:

• C+S+T+M(From supply side)

• Y=C+I+G+X(From demand side)

• an extensive GNP model

• From supply side ： Y=C+S+T+M+Rf+Wf

• Where,Rf–incomes of foreign investors in home country;Wf –wages of foreigners in home country 。

• From demand side ： Y=C+I+G+X+If+Wh

• Where,I f-incomes from oversea’s Wh—wages of residents in foreign countries.

• Consider the information shock as parameters,then,

1

1 2 3 4 5 6

1 2 3 4 5 6

Y C S T M Rf Wf

Y C I G X If Wh

3/25/10

3.2Method 2:Based on Structural equations

See the attached figure

3/25/10

4.Data and Tests of the models

• Further studies

3/25/10

5.Conclusions and implications of policy

To think about

3/25/10