Lessons from Financial Crises Handout

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Lessons from Financial Crises Handout

Kenneth Rogoﬀ, Harvard University Eli F. Heckscher Lecture

Stockholm, September 2, 2014

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Insights from New Comprehensive Historical Data Bases

•  Reinhart and Rogoﬀ (2003, 2008…….., 2009 THIS TIME IS DIFFERENT)

•  IMF 2011

•  Taylor (2012)

•  Mauro et al (2013)

•  Many others…

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Reinhart Rogoﬀ based on large

historical database covering over 70 countries and eight centuries

•  Annual data on prices, exchange rates,

interest rates, government spending, taxes, commodity prices, output, sovereign debt, capital ﬂows….

•  DaXng of crises, including inﬂaXon, banking, sovereign external debt, sovereign domesXc debt, exchange rate crises

Kenenth Rogoﬀ, Harvard University

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New data and coverage, for example:

•  Far more comprehensive coverage of world than any previous study, including liYle

studied crises in Asia and Africa, Europe

•  First comprehensive long-‐dated historical database on domesXc debt (later replicated and extended by IMF team)

•  Historical data on housing prices across a large number of countries

Kenneth Rogoﬀ, Harvard University

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The appearances, disappearances and

reappearances of debt, banking and inflation crises over time (Qian, Reinhart and Rogoff, 2010)

1550 frequent in

advanced economies (including the "world powers" of the time) Napoleonic Serial in some cases

wars end 1815

1826 frequent in serial in advanced/ rare 1850 "peripheral' advanced in emerging

1900 economies and most serial in advanced/ more

WWI begins 1913 emerging markets frequent in emerging frequent in advanced

WWII ends 1945 rare in advanced and and emerging

post-1945 emerging

1964

1973 frequent in advanced

early 1980s more frequent in and emerging

early 1990s advanced/serial frequent in emerging

2000 Serial in some in emerging 2009 emerging markets

2010

rare

rare Inflation

crises Banking

crises

rare rare

External debt crises

?? 5

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Kenneth Rogoff Harvard 6

Sovereign Default Cycles 1800-‐2009

Sovereign External Debt: 1800-2006

Countries in Default Weighted by Their Share of World Income

0 5 10 15 20 25 30 35 40 45

1800 1807

1814 1821

1828 1835

1842 1849

1856 1863

1870 1877

1884 1891

1898 1905

1912 1919

1926 1933

1940 1947

1954 1961

1968 1975

1982 1989

1996 2003 Year

Percent of world Income

All countries in sample

Excluding China

Source: Reinhart and Rogoff, 2009

Is this time different?

Greece in default 50% of years

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DEFAULT in Modern Emergning Markets

Country Share of Years in Default from

Independence/1800

Number of Defaults

GREECE 51 5

HUNGARY 37 7

SPAIN 24 13

ARGENTINA 32 8

BRAZIL 25 9

HONDURAS 64 3

VENEZUELA 38 10

Kenneth Rogoﬀ Harvard

Source: Reinhart and Rogoﬀ THIS TIME IS DIFFERENT, p. 99

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Number of years since the last external default, since year of independence (if there is no default) or since 1800 (if there is no default and independence was earlier)

High income countries

SOURCE: QIAN, Reinhart and Rogoff, 2010

1965

1949 1945

1917 1907

1905 1901

1867

1830

0 20 40 60 80 100 120 140 160 180 200

Hungary Greece Singapore Germany Austria Japan Taiwan Italy Korea Finland New Zealand Norway Portugal Australia Spain Canada Belgium Netherlands Sweden France United States United Kingdom Denmark

Years since last external default crisis

Median 104

8

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And newer manifestaXons of crisis

IMF Programs:

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0 2 4 6 8 10 12 14 16 18

1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007

0 5 10 15 20 25 30 35 Share of advanced economies 40

with IMF programs (bars, left scale)

Share of emerging markets with IMF programs

(line, right scale)

The Incidence of IMF Programs : 1952-2007

Advanced economies were no stranger to IMF programs through the early 1980s

Source: Qian, Reinhart and Rogoff, 2010 10

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Looking at History Extremely Useful for AnXcipaXng and Understanding the Crisis

•  Reinhart and Rogoﬀ (Jan 2008 – later chapter 13 of book) show that by many macro indicators, US was in danger of having a severe economic crisis

•  Reinhart and Rogoﬀ (January 2009, later chapter 14 of book) show quanXtaXve indicators of ﬁnancial crisis

•  Reinhart and Rogoﬀ (January 2010, August 2010,

August 2012) show that high public and private debt overhang are associated (not necessarily causal) with modest but sustained reducXon in long-‐term growth, also many other papers by IMF, BIS, ECB with similar results. This does not, of course, obviate the necessity of public debt rising sharply during the crisis and in its ahermath as RR (2009) document.

Kenenth Rogoﬀ, Harvard University

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Kenneth Rogoﬀ Harvard Spain (1977), Japan (1992), Norway

(1987) Philippines (1997), Sweden (1991), Hong Kong (1997), Colombia (1998), Korea (1997), Malaysia (1997), Finland (1991), Thailand (1997)

Indonesia (1997), Argentina (2001),

Cumulative % change

Duration

Housing prices

-36%

⁵^years

Equity prices

-56%

^3.4^years

Unemployment

7%

^4.8^years

Real GDP

per capita

-9.3%

^1.7^years

Past Experience with Severe Financial Crisis, Peak to Trough Changes

Reinhart and Rogoﬀ, 2009

“The Ahermath of Financial Crises”

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Extending quanXtaXve analysis to earlier crises yields similar results

•  Reinhart and Rogoﬀ (2014) explore 100 ﬁnancial crises in advanced countries and emerging

markets from 1870-‐2013

•  Average duraXon of crises is 8 years in advanced countries, average cumulaXve loss of output is 10% (important data caveats pre-‐WW II)

•  Double dips quite common, showing that standard recession daXng methods do not extend well to

recessions associated with ﬁnancial crises.

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Percent

-15 -10 -5 0 5 10

1892 1893 1894 1895 1896 1897 1898 1899 1900 1901

Number of years peak-to-trough is 2

Number of years peak to recovery is 6

Peak-to- trough change is -14.2%

Double dip:

A renewed downturn before reaching prior peak

Note: The severity index for this episode is 20.2

IllustraXon using US Banking Crisis of 1893: Double dip and Severity index

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Percent

-30 -28 -26 -24 -22 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10

1790 1805 1820 1835 1850 1865 1880 1895 1910 1925 1940 1955 1970 1985 2000

Years of systemic banking crisis/panics are noted

1814-1817

1837-1840s 1873

1893 1907

1929-1933

2008-2009

DeviaXons of real per capita output from its previous peak: United States 1790-‐2013

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Rank Country and

Year Peak to

Trough Peak to

Peek Severity

Index Double Dip?

5 Australia 1893 -‐28%, 8 yrs. 20 yrs. 48 yes 9 Canada 1923 -‐30% 4 yrs. 10 yrs 40 no 14 US 1929 -‐29%, 4 yrs 10 yrs 39 yes 17 Greece, 2008 -‐24%, 6 yrs 12 yrs 36 yes 22 UK, 192 -‐19%, 3 yrs 11 yrs. 30 yes 27 Ireland, 2007 -‐13%, 3 yrs 12 yrs 25 yes 29 Italy, 2008 -‐11%, 6 yrs 12 yrs 23 yes

Reinhart Rogoﬀ (2014) ranking of 35 most severe ﬁnancial crises since 1870: Selected Episodes

Source: Reinhart and Rogoﬀ, 2014 Kenneth Rogoﬀ, Harvard University

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0 10 20 30 40 50 60 70 80 90 100

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

Unweighted Average Advanced economies

Public Debt as Percent of GDP : Advanced Economics, 1900-‐2013

Source: Reinhart-‐Rogoﬀ database

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Despite rising trend government

spending, few economists quesXon the case for greater spending on

genuinely producXve infrastructure projects: low interest rates and high unemployment make a compelling

case for infrastructure in both

Keynesian and classical models…

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But in absence of defaults,

restructuring or inﬂaXon, private debt

and external debt, do not fall much

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0 50 100 150 200 250 300

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Gross Total (Public + Private) External Debt, 22 Advanced Economics, 1970-‐2013

Source: Reinhart-‐Rogoﬀ database Kenneth Rogoﬀ, Harvard University

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As a result, public and private debt

overhang remains a serious issue

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0 50 100 150 200 250 300 350 400

1916 1930 1944 1958 1972 1986 2000 2014

GSE Financial Corporate Household Public

Reinhart, Reinhart and Rogoﬀ (2014) based on Buoglione, Lane, Reichlin and Reinhart (2014),

US Debt by Sector as a Percent of GDP, 1916-‐2014

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US and UK have deleveraged far more than Europe….

Source: Lo and Rogoﬀ, BIS Working Paper 2014

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WAYS TO ESCAPE VERY HIGH PUBLIC and PRIVATE DEBTS

•  Very high growth

Virtually every study

shows that high growth less likely with high debt

•  Default

•  A burst of inﬂaXon

•  Financial repression

•  Extended period of debt overhang

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Advanced economy output and inﬂaXon trends 1990-‐2013

Reinhart, Reinhart, and Rogoﬀ 25

-1 0 1 2 3 4 5 6 7 8 9

1990 1993 1996 1999 2002 2005 2008 2011

Advanced economies: Components of nominal GDP moving average of three-year change, percent

Potential output

Real GDP

Nominal GDP Inflation

Source: Reinhart, Reinhart and Rogoﬀ, 2014

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Many alternaXve explanaXons of slow growth in advanced countries

Kenneth Rogoﬀ Harvard University

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Dealing with zero bound on interest rates

•  Blanchard (2010), Krugman (2014):

–  Raise inﬂaXon targets to 4%

•  Rogoﬀ (1997, 2014), Buiter (2008)

– Phase our paper currency,

– pay posiXve interest rates on money in normal Xmes

–  eliminate arXﬁcial zero bound on interest rates aher catastrophes

•  ,

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Country/

Region Currency in

CirculaFon % notes ≥ 50

USD value %GDP US 1.20 trillion $ 83% 7%

Euro 0.96 trillion € 90% 10%

Japan 907 trillion ¥ 90% 19%

HK dollar .301 trill HK $ 81% 15%

Currency in circulaXon in large denominaXon notes (end 2013)

Source Kenneth Rogoﬀ, 2014, NBER Macro Annual

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Reform of the Financial System

•  Much higher equity ﬁnance (Admadi-‐Hellwig)

•  Hybrid debt (converXble conXngent bonds, debt that makes payments in equity when stock collapses (Bulow-‐Goldfeld-‐Klemperer)

•  Narrow Banking

•  1930s “Chicago Plan” to essenXally prohibit near monies that are ﬁnanced by maturity transformaXon

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Kenneth Rogoff Harvard

Lessons from Financial Crises Handout