western hemisphere department international monetary fund barbados january 25, 2011

The Global Financial Crisis: Why It Happened, and Options for National and International Policy Change

A comparative overview of the crisis and macro-economic policy responses so far

Western Hemisphere DepartmentInternational Monetary Fund

BarbadosJanuary 25, 2011

Trevor Alleyne

The world is recovering from the great recession, but huge challenges remain

The impact of the crisis

How the crisis happened

Why this recession is different

The causes of the crisis

Policies to sustain the recovery

Lessons from the crisis

Main challenges faced by the Caribbean

2

The Crisis—Impact on GrowthGlobal growth fell sharply during the crisis everywhere in the world

Emerging anddeveloping economies

World

Advanced economies

3

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

2006 07 08 09 10 11

IMF Forecasts

3

Source: IMF WEO (October 2010).

Global GDP Growth(percent, quarter-over-quarter, annualized)

The Crisis—Impact on the World

4

Wiped out over $2 trillion in bank assets Plunged most of the world into a global recession

Over 30 million more people became unemployed (ILO)

30-50 thousand more babies may die in Africa in 2010 (World Bank)

About 64 million more people have fallen into extreme poverty by 2010 (World Bank)

5

The Crisis—Impact on the World

Advanced Economies

Emerging and Developing Countries

World

4.50

5.00

5.50

6.00

6.50

7.00

7.50

8.00

8.50

2006 2007 2008 2009

Onset of the crisis

6

The Crisis—Impact on UnemploymentUnemployment rose sharply in developed and developing countries

Source: IMF WEO (April 2010).

Global Unemployment Rate(percent)

Caribbean: Real GDP Growth 1/(annual percentage change)

Source: IMF WEO (October 2010).1/ Caribbean countries include Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago.

2006 2007 2008 2009 2010-15

-10

-5

0

5

10

15

20

-15

-10

-5

0

5

10

15

20

7

The Crisis—Impact on the CaribbeanSevere recession followed by a slow recovery of growth

Caribbean: Unemployment Rate 1/(percent)

Source: IMF WEO (October 2010).1/ Caribbean countries include Bahamas, Barbados, Belize, Jamaica, Suriname, and Trinidad and Tobago. Data for ECCU countries are not available.

2006 2007 2008 2009 20100

5

10

15

20

0

5

10

15

20

8

The Crisis—Impact on the Caribbean… higher unemployment…

Public Debt 1/(percent of GDP)


2006 2007 2008 2009 20100

50

100

150

200

250

0

50

100

150

200

250

9

The Crisis—Impact on the Caribbean… and a sharp rise of public debt/GDP ratios

Let’s look at where the crisis began…In U.S. and European banks

10

The Crisis

Lots of liquidity sloshing around

Asset bubbles

Crisis starts in advanced countries

Banking crises

Creditcrunch Recession

Wea

k re

gu

lati

on

Excess risk

Weak supervision

Advanced economies

11

Advanced economies affected

-2.5

1.2

-4.1

-5.1

-1.9

0.8-5.20.2

-1.6

-1.4

-1.3

-4.7

-2.8

-4.9

-2.6

-6.8

-4.1 Euro Area-1.9

12


(2009 growth rate)

Asset bubbles

Crisis spreads to emerging economies

Banking crises


Advanced economies


Emerging economies

Trade collapsed - Capital flows stopped

13

Emerging economies affected

0.9

-0.2

-1.5

0.8

9.1

5.7

4.5

-1.7

-6.5

-3.4

0.9

1.1

-1.8

-2.2-3.3

v

-4.7

-6.3

-18.0

-7.1

-14.8

1.7

-7.9

-15.1

-13.9

14

(2009 growth rate)


Asset bubbles

Low-income countries

Banking crises


Advanced economies


Emerging economies

RecessionLow-income economies

Trade collapsed - Capital flows stopped

15

16

Why is this recession different?

Recessions associated with financial crises are severe and recoveries from such recessions are typically slow. These features become more pronounced if in addition the recession is global.

Countercyclical policies are helpful in ending recessions and strengthening recoveries. Their effectiveness depends on the type of recession.

0 2 4 6 8

Financialcrises which

are highlysynchronized

Highlysynchronized

recessions

Financialcrises

All recessions

Output loss (percent from peak)

Duration (quarters)

Features of Recessions and Recoveries Depend on the Type of Recession…

Recessions Recoveries

0 2 4 6 8

Financialcrises which

are highlysynchronized

Highlysynchronized

recessions

Financialcrises

All recessions

Time until recovery to previous peak(quarters)Output gain after four quarters (percent fromtrough)

17

Policies Help Shorten Recessions… Fiscal Stimulus is Effective in Financial Crises…

0.0

0.2

0.4

0.6

0.8

1.0

0 1 2 3 4 5 6 7 8 9 10

Quarters

Full sample

Financial crises

Financial crises with high fiscal response

18

Probability of remaining in a recession beyond a certain number of quarters

19

In the Caribbean, high public debt/GDP ratios have weakened growth and narrowed the fiscal space

10 40 70 100 130-6

-4

-2

0

2

4

6

-6

-4

-2

0

2

4

6

-1.9

-3.0

0.5

4.5

-3.4

-2.8

-1.6

-3.5

-2.0

-0.2

-1.2

Ave

rag

e r

ea

l GD

P g

row

th,

20

09

–1

0

Public Debt, 2008 (percent of GDP)

Public Debt Burden and Real GDP Growth

Growth has been weaker in countries with higher debt levels...

JAM BHS BRB ECCU DOM TTO-4

-3

-2

-1

0

1

2

-20

-15

-10

-5

0

5

10

Change in primary deficit (percent of GDP)¹

Real primary expenditure growth minus potential GDP growth (percent, right scale)

Change in Primary Deficit and Primary Expenditure Growth, 2010

... where fiscal space remains constrained.

Why did the crisis happen?

Market discipline and regulations failed to keep up with innovation and leverage build up

Macroeconomic policies did not respond to increase in systemic risk

Leadership needed at the international level to detect and respond to risks

20

21

What can be done to foster the recovery?: A consistent policy framework

Accommodative monetary policy and continued support for banks to support credit and demand.

Repair and reform financial systems.

Medium-term fiscal consolidation plans, including to build credibility and new room for policy maneuver.

Structural reforms and exchange rate flexibility to boost domestic demand in key EM.

Employment promotion and protect the most vulnerable.

If recovery threatens to stall: (i) further monetary easing; (ii) in countries with fiscal room, allowing automatic stabilizers to play and postponing some consolidation.

22

Monetary policy needs to remain accommodative, but there are limits to its effectiveness (as long rates are very low)

-200

-100

0

100

200

300

400

500

-6

-3

0

3

6

9

12

15

Change from March, basis points, RHS

August long-term interest rates, percent, LHS

Change in Long-Term Bond Yield, 2010 1/(basis points)

AU

S

AU

T

BE

L

CA

N

CZ

E

DN

K

FIN

FR

A

DE

U

GR

C

HK

G

IRL

ISR

ITA

JPN

KO

R

NL

D

NZ

L

NO

R

PR

T

SG

P

SV

K

ES

P

SW

E

TW

N

GB

R

SV

N

US

A

1/ AUS: Australia; AUT: Austria; BEL: Belgium; CAN: Canada; CZE: Czech Republic; DNK: Denmark; FIN: Finland; FRA: France; DEU: Germany; GRC: Greece; HKG: Hong Kong SAR; ISL: Iceland; IRL: Ireland; ISR: Israel; ITA: Italy; JPN: Japan; KOR: Korea; NLD: Netherlands; NZL: New Zealand; NOR: Norway; PRT: Portugal; SGP: Singapore; SVK: Slovak Republic; SVN: Slovenia; ESP: Spain; SWE: Sweden; TWN: Taiwan Province of China; GBR: United Kingdom; USA: United States.

23

Financial sector repair and reformneed to accelerate

Recapitalize/resolve banks

Repair markets for securitized assets

Re-establish market discipline

Implement regulatory reform with a broader and more global view (broaden the regulatory perimeter and foster cross-border coordination among regulators)

24

Medium-term fiscal plans are urgently needed

Projected Change in Cyclically Adjusted Primary Balances(percent of potential GDP)

Source: FAD staff estimates.1/ In percent of GDP; distance from blue bar reflects required additional fiscal adjustment relative to 2010-13; adjustment to be sustained between 2020–30 to reduce public debt to prudent levels.2/ Structural primary balance.3/ Excluding financial sector support recorded above the line.

Ge

rma

ny

Ca

na

da

Un

ited

Sta

tes

2/

Fra

nce

Italy

Jap

an

3/

Un

ited

Kin

gd

om

Ire

lan

d

Po

rtu

ga

l

Sp

ain

Gre

ece

-5

0

5

10

15

20 Change 2013-2011Change 2011-2010Change 2010-2009Additional adjustment between 2013-2020 1/

25

Dealing with inflow surges: Exchange rate flexibility and capital controls

Fiscal and monetary stimulus policies are leading to capital inflow surges in emerging economies

Macro and prudential policies can help deal with the downsides of inflow surges (appreciation and inflation)

Macro policy space (especially exchange rate) must be exhausted before imposing capital controls

Capital controls and prudential measures should target specific risks

Prudential measures when flows intermediated through the regulated financial institutions

Capital controls when flows by-pass regulated financial institutions

26

Foster employment and protect the most vulnerable

ILO/IMF collaboration (Oslo Conference 9/2010)

The crisis will not be over until unemployment falls

Growth is essential for employment, but it is not enough

Job creation must be a priority

Specific policies are needed to protect the poor and the vulnerable (social protection floor)

Programs to subsidize short-term work and on-the-job training

Unemployment benefits

Job subsidies

27

Over the medium term, what are the main lessons for policy makers on the macroeconomic level?

Monetary policy should respond to the buildup of systemic risk (focus on macro-financial stability)

Fiscal policy should be put on a stronger footing in good times (to open up fiscal space for countercyclical fiscal stimulus in bad times)

While international capital flows are on the whole beneficial, global imbalances have to be addressed

The world is recovering from the great recession, but huge challenges remain

Unemployment

Fiscal sustainability

Sources of growth

Financial sector reform

Capital flows to emerging markets

✓

✓

✓

✓

✓28

As the Caribbean recovers from the great recession, it faces significant challenges going forward

Promoting growth- Energy and infrastructure- Human capital- Competitiveness- Diversification

Fiscal sustainability- Reducing debt-to-GDP ratios- Creating fiscal space to allow for

countercyclical policy

Financial sector- Strengthening regulations, particularly for

nonbank FI- Resolving CLICO

✓

✓

✓

Climate change✓29

30


Caribbean: Real GDP Growth 1/(annual percentage change)

Growth is projected to be lower than in the past

1990-99 avg. 2000-02 avg. 2003-08 avg.0

1

2

3

4

5

3.1

1.9

3.8

2011 2012 2013 2014 20150

1

2

3

4

5

2.4

2.8

3.2 3.2 3.2

31

Medium-term fiscal plans are urgently needed

Caribbean: Projected Change in Cyclically Adjusted Primary Balances(percent of potential GDP)

An

tig

ua

& B

arb

.

Ba

ha

ma

s

Ba

rba

do

s

Be

lize

Do

min

ica

Gre

na

da

Gu

ya

na

Ja

ma

ica

St. K

itts

& N

evis

St. L

ucia

St. V

ince

nt &

th

e G

ren

ad

ine

s

Su

rin

am

e

Tri

nid

ad

& T

ob

ag

o

-15

-10

-5

0

5

10

15

20Change 2013-2012

Change 2011-2010

Change 2010-2009

Source: WHD staff estimates.

32

Financial Sector

Strengthening the financial sector requires

Upgrading the legislative and supervisory framework for

Commercial banks

Nonbank financial institutions

Intensifying monitoring and on-site inspections, and more frequent reporting

Consolidated supervision of conglomerates

Agreements and closer collaboration for cross-border supervision

Urgent resolution of CLICO

A transparent resolution process

Minimize fiscal costs and contingent liabilities

Thank You

western hemisphere department international monetary fund barbados january 25, 2011

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