the great leveraging (taylor nber & cepr november 2012)

7/29/2019 The Great Leveraging (Taylor NBER & CEPR November 2012)

1/15

The Great Leveraging

Five Facts and Five Lessons for Policymakers

Alan M. Taylor

University of Virginia, NBER & CEPR

International Banking Conference

Federal Reserve Bank of Chicago and CEPR

1516 November 2012

1


2/15

Fact1.Crises:Almostforgo4en:nowtheyreback

A long standingproblem

For DM and EM Exception: 1940 to

1970 periodunusually quiescent.

Why?

Internal orexternal

constraints?

2

0

10

20

30

40

50

60

70

Percentageofeconomie

sinafinancialcrisis

1800 1850 1900 1950 2000

High-income economies Middle- & low-income economies


3/15

Fact2.Consequences:forgotdepressing/deflaonaryimpacts

Evidence-basedmacroeconomics

Event study 14 advanced

countries

140 years of data Recessions are painful

Those withfinancial crises aremore painful

Those with globalfinancial crisesare worse still

Prewar versus Postwar

3

-.

025

-.0

2

-.

015

-.01

-.

005

0

Prewar Recessions Postwar Recessions

NormalCrisis

Global CrisisNormal

Crisis

4 year windows before/after recession peak

Change in real GDP growth rate

-.

04

-.

03

-.0

2

-.0

1

0


NormalCrisis

Global CrisisNormal

Crisis


Change in inflation rate

-.0

8

-.

06

-.

04

-.

02

0


NormalCrisis

Global CrisisNormal

Crisis


Change in real loan growth rate


4/15

Fact3.Extremeleverage:historicallyunprecedented

Then Age of Money

Now Age of Credit

How? More leverage Wholesale

funding

Why? Private actions

(recovery from

GD/WW2)

Governmentpolicies

(financial

liberalizations)

4

0

.5

1

1.

5

2

ratio

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Bank Loans/GDP Bank Assets/GDP Broad Money/GDP


5/15

Fact3.Extremeleverage:banksversussovereigns

5

.2

.4

.6

.8

1

ratio

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Bank Loans/GDP Public Debt/GDP

Advanced countries Public debt crisis/

excess?

There is a post2008 blip

Private credit crisis/excess?

Larger andtrending up since

1990

Reversal of ratiosstriking after 1960 Safe assets?


6/15

Fact.Globalasymmetry:EMsbuyinsurance,DMssellit

Post-1990s EMsswitch to safer,

countercyclical

polices and larger

buffers

Great ReserveAccumulation

Unique phase inhistory?

Gold standard Net capital flows

Private inflows Official outflows

No Lucas paradox?

6

-1

000

-500

0

500

1000

U.S.

$

billion

1980 1990 2000 2010

EM Official Flows EM Private Capital F lows

EM Official & Private BOP Account Flows

0

2000

4000

6000

U.S.

$

billions

1999q12001q12003q12005q12007q12009q1

Emerging markets Developed markets

EM & DM NIIP Account Official Reserves Stocks


7/15

Fact5.Savingsglut:shortrunpanicv.longrundemography

Short term reasons to think theera of cheap capital is over

Investment rebound in EMand DM after panic?

Not quite yet! EM reserve step change

completed? DM delevering slow?

Longer term reasons? Demography

Offsetting/postponing factor Recurrent and ongoing

flights to safety in panic

Real rate = 0% in Jun 2012!7

50

60

70

80

90

Dependentsasapercentageofworkingage(2064)

1970 1980 1990 2000 2010 2020 2030 2040

World More developed regions Less developed regions


8/15

Summingupthefacts

An Inconvenient Truth Crises just a fact of life in modern finance capitalism? Exception was 195070 with financial repression, regulation, controls. Period of low credit creation. But it was also still a period of high growth.

Plus A Series of Unfortunate Events

Cheap capital in asymmetric world. Credit boom.

Good = productive projects. Bad = risk of boom-bust cycle. Sequel

Hunger for safe assets, demographic shifts slow (but coming). Low real rates for now= deflationary shock continues, and credible

sovereigns can be funded.

Next What lessons for policy in this kind of financial landscape Macro policy / Financial policy

8


9/15

Lesson1:Pastprivatecreditgrowthdoescontainvaluable

predicveinformaonaboutlikelihoodofacrisis

Schularick and Taylor 2012AER Credit Booms GoneBust

Use lagged credit growthT5,..,T1

Forecast of a financial crisis{0,1} in year T

Ex ante credit boom makesa financial crisis morelikely

Beats null (cointoss) Beats narrow or broad

money

Robust to other controlsincluding macro, interestrates, and stock prices

9

0.0

0

0.2

5

0.5

0

0.7

5

1.

00

T

rue

positive

rate

0.00 0.25 0.50 0.75 1.00True negative rate

Null, FE only (AUC = 0.640) Credit + FE (AUC = 0.750)

Money + FE (AUC = 0.686) Reference


10/15

Lesson2:Externalimbalances/publicdebtsareadistracon

Jord, Schularick,Taylor 2011 IMF

Economic ReviewFinancial Crises,Credit Booms, andExternal Imbalances:140 Years of Lessons

Couldnt it all be downto external imbalancesrather than internal? Add current account

(%GDP) to the forecastsystem and run a horserace.

As a policymaker, whichsignal has more valuable

information aboutincipient financialfragility?

Not CA/GDP Same result holds for

public debt/GDP

10

0.0

0

0.2

5

0.5

0

0.

75

1.0

0

True

positive

rate



CA + FE (AUC = 0.685) Credit + CA + FE (AUC = 0.767)

Reference

0.0

0

0.2

5

0.5

0

0.7

5

1.0

0

True

positive

rate



Pub. debt + FE (AUC = 0.645) Credit + pub. debt + FE (AUC = 0.747)

Reference


11/15

Lesson3:AQeracreditboom,expectamorepainful

recession,normalorfinancial-crisis

11

-40

-30

-2

0

-10

0

10

LeveloflogrealGDPpe

rcapitainyear1-5,orthogonalcomponent

-4 -2 0 2 4Excess credit in prior expansion, orthogonal component

coef = -.50628744, se = .17115664, t = -2.96

Normal recessions

-40

-20

0

20

LeveloflogrealGDPpercapitainyear1-5,orthogonalcomponent

-2 0 2 4 6Excess credit in prior expansion, orthogonal component

coef = -.76393738, se = .22300767, t = -3.43

Financial recessions

Credit boom before v lost output afterwards Jord, Schularick, Taylor 2012 When credit bites back Larger credit boom ex ante correlates with deeper recessions in each case

In addition to the larger credit boom making more painful financial crisis case more likely to occur


12/15

Lesson:Inafinancialcrisiswithlargerun-upinprivate

sectorcredit,markdowngrowth/inflaonmore

12

Credit boom before v other outcomes Jord, Schularick, Taylor 2012 When credit bites back Larger credit boom ex ante correlates with deeper recessions in each case

In addition to the larger credit boom making more painful financial crisis case more likely to occur Also depressing for investment and inflation outcomes

Financial

Normal

-10

-5

0

5

10

0 1 2 3 4 5

Real GDP per capita

-30

-20

-10

0

10

0 1 2 3 4 5

Real Investment per capita

0

5

10

15

20

0 1 2 3 4 5

CPI Prices

Cumulative Change From the Start of the Recession


13/15

Lesson5:Inafinancialcrisiswithlargepublicdebt,and

largerun-upinprivatesectorcreditmarkdowngrowth/

inflaonevenmore

JST, work in progress

Zero reference = notreatment

Blue = normal recessionafter +1% extra credit/GDP ppy treatment

Red = financial recessionafter +1% extra credit/GDP ppy treatment

Lt gray = Blue line pathas public debt/GDP varyfrom 0% to 100%

Dk gray = Red line pathpublic debt/GDP varyfrom 0% to 100%

13

Financial: Debt/GDP = 100%


Normal: Debt/GDP = 0%




-4

-3

-2

-1

0

1

2

Percent

1 2 3 4 5 6Years

Financial crisis recession: Debt/GDP = 0100%Normal recession: Debt/GDP = 0100%

Normal recession: Debt/GDP = 50% Financial crisis recession: Debt/GDP = 50%

Real GDP per Capita

Change in growth rate in each year after start of recession


14/15

Summingupthelessons

Pre-crisis prevention

Central bank complacency, with two obvious and key failures Inflation targeting not enough, unable to avert credit boom/bust crisis

Didnt we know this already from history of the gold standard, etc.? Not having well thought out banking supervision/resolution, LOLR regime

Ditto

Both failures present with a vengeance in the Eurozone with amplificationfactors

Post-crisis response What will the path look like?

Worse than people thought/think

Massive deflationary shock; CBs beware of premature tightening ECB rate rise in 2011? Fed/BoE/BoJ responses more accomodative, but large headwinds also

14


15/15

The Great Leveraging

Five Facts and Five Lessons for Policymakers

Alan M. Taylor

University of Virginia, NBER & CEPR

International Banking Conference

Federal Reserve Bank of Chicago and CEPR

1516 November 2012

15

the great leveraging (taylor nber & cepr november 2012)

Documents