Untitled Quiz

Crises of Financial Openness

• Financial and currency crises are interconnected events.
• The presentation outlines various crises, including the Great Depression, the Asian Financial Crisis, the Great Recession, and the 2020 Pandemic.

Review Questions

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• They need to enter an event code (AXNJZJ) in the top banner.
• They can enable answers through SMS.

Game Plan

• The 1929-1939 Great Depression is included in the game plan.
• The 1997-1998 Asian Financial Crisis is also included in the game plan.
• The 2007-2009 Great Recession is addressed in the game plan.
• The 2020 Pandemic is also included in the game plan.

Great Depression

• The Great Depression was the longest and most severe crisis in the Western industrialized countries.
• In the US, real GDP fell by 29% from 1929 to 1933.
• Unemployment peaked at 25% in 1933.
• Consumer prices declined by 25%.
• Approximately 7,000 banks (nearly a third of the banking system) failed.
• In Europe, manufacturing decreased by 39%, and unemployment reached 44% in Germany.
• Prices in most European countries fell by 30% or more.

Great Depression - The Run-Up

• Western nations returned to the Gold Standard in the 1920s, despite persistent imbalances.
• The US had a current account surplus, while some European countries had deficits.
• European nations had accumulated war debts and reparations, which flowed to the US.
• The US, instead of allowing price adjustments, lent money back to Europe via international bonds.
• A significant increase in credit and international bonds occurred in the US.

Onset of the Great Depression

• The US enacted tighter monetary policies to control stock market speculation, leading to a crash.
• The immediate effect was a loss of wealth.
• Uncertainty about the economic future decreased consumption of consumer durables.
• Banks invested heavily in the stock market and started failing.
• The Smoot-Hawley tariffs and retaliatory actions caused a collapse in international trade.
• Bank failures occurred due to the absence of deposit insurance.

Bank Runs

• Fractional reserve banking is a system where banks keep less than 100% of their deposits in reserve.
• They loan out the remainder, generating profits.
• Customers started doubting the ability of banks to return deposits.
• More customers withdrew funds.
• The more people feared bank failure, the more likely it became to happen.
• This is known as a self-fulfilling prophecy.

Where Was the Federal Reserve?

• Many local banks were not members of the Federal Reserve system.
• This meant they couldn't borrow from the Fed when in a crisis.
• Interest rates were nominally set at zero.
• Deflation made borrowing and investment very costly.
• Attempts to maintain the Gold Standard hindered effective monetary policy for banks.

Great Depression Spreads to Europe

• The Gold Standard dictated that Europe needed to mirror the US contraction.
• Loan flows from the US to Europe ceased.
• European consumer markets declined as the US market did.
• The depression hampered industrial production in Europe.
• Deflation made debts from World War I and reparations more difficult to repay.
• European banks also started failing.

What Led to "Recovery"?

• The US declared a bank holiday and established temporary deposit insurance to curb bank runs.
• Increased gold inflows from Europe alleviated borrowing costs.
• FDR's 'New Deal' initiated increased government spending.
• Ultimately, the breakdown of the Gold Standard, bank rescues, and increased monetary policy, along with the beginning of WWII, drove economic recovery in both the US and Europe.

The Role of Economic Ideas - Government Stimulus and Bailouts

• A debate arose between Keynesian economics and Austrian economics regarding the causes and remedies of the crisis.
• Initially, Keynesian ideas were the dominant school of thought until the 1980s.

Financial and Currency Crises in Emerging Markets 1990s

• This section focuses on the financial and currency crises experienced by emerging markets in the 1990s.

Volatility in Private Capital Flows

• There was a surge in private capital flows to newly liberalized developing countries.
• Asia and Latin America were significant recipients of this capital.
• Hot money, easily withdrawn, led to increased volatility in emerging markets and crises.
• Specific crises are listed: Mexico (1994), Indonesia, Malaysia, South Korea, Thailand (1997), Brazil and Russia (1998), Turkey (2000), and Argentina (2001).

Commonality Across Crises

• Fixed exchange rates are common in affected countries.
• Reliant on short-term capital.
• Continuous rollover of foreign liabilities.
• The government's ability to maintain confidence in fixed exchange rates is crucial.
• Shocks (political, economic, and contagion) lead to confidence eroding, capital outflow, and a forced government devaluation.

Asian Financial Crisis: A Risky Banking System

• Liberalized financial markets in Asia.
• Domestic banks had increased their borrowing from international markets.
• Banks acted as intermediaries, borrowing at low international rates and lending at higher domestic rates.
• Short-term loans in foreign currencies, frequently converted into domestic currencies, created vulnerability.
• Exchange rate risks and rolling-over loans are significant risks here.

A Risky Banking System (Ctd)

• Moral hazard in banking regulation.
• Banks believe in government bailouts and take more risks.
• Close ties between financial institutions and governments.
• Underdeveloped and unenforced financial regulations.

Shocks to the System

• In the mid-1990s, Asian currencies began appreciating against the yen.
• Most Asian governments pegged their currencies to the dollar.
• These actions triggered difficulties in trading with Japan.
• Debt-service problems emerged for export-oriented firms due to currency shifts and falling real estate prices.
• Financial collapses ensued in Thailand, Indonesia, Malaysia, and South Korea.

Contagion

• Panic started in Thailand and spread quickly.
• Currency pegs were abandoned and currency devaluations occurred.
• Capital outflow was significant.

The Repercussions

• IMF loans were issued in exchange for economic reforms.
• These reforms included policies tightening monetary and fiscal measures,
• Trade liberalization, elimination of domestic monopolies and privatization.
• Consequences included deep recessions and rising poverty.
• Political unrest and regime changes occurred.

A Lesson Learned

• Avoiding market sentiment shifts and IMF intervention was advised as a learned lesson.
• Accumulating foreign exchange reserves was recommended as a measure of self-insurance.
• Pegging currencies to the dollar for stability was also suggested.
• Also, sterilized intervention to control domestic money supplies, and regional frameworks for financial cooperation to avoid reliance on the IMF were highlighted as learned lessons.

Great Recession 2007-2009

• The Global financial crisis is noted as originating between 2007-2009.

Global Imbalances

• There were considerable global imbalances and imbalances in current accounts of nations.

Global Imbalances: International Bargaining Failure

• The US blamed China for having a massive current account surplus, leading to a flow of cheap credit from China to the US.
• Other nations and the Euro zone also had similar issues.
• There was a failure to address the crisis internationally.

Cheap Credit in US Fuels Real Estate Bubble

• US real estate prices dramatically increased between 2000 and 2006.
• Mortgage-backed securities increased enormously.
• Huge risk in mortgage-backed securities and real estate was discounted nationwide.
• Real estate prices dropped by almost 25% worldwide.

Mortgage Defaults Rise Sharply

• Mortgage defaults increased substantially, leading to issues with securities and debt-service problems.

The Crisis Becomes International

• The crisis spread to the UK, Ireland, and Spain, due to similar real estate bubbles collapsing.
• European financial institutions held substantial mortgage-backed securities and experienced losses similar to those in the US.
• The bankruptcy of Lehman Brothers halted global credit markets.
• Inter-bank lending interest rates rose sharply.

Policy Reaction: Bank Bailouts

• The US government intervened by closing banks and arranging sales.
• Banks deemed "too big to fail" received bailouts from the US and EU governments.
• Ireland was subject to severe bailouts.

Policy Reaction: Monetary Policy

• Central banks injected substantial liquidity into markets starting in 2007.
• Unconventional monetary policies like quantitative easing were used.

Central Banks Lower Interest Rates to 0

• Central banks dropped interest rates to effectively zero in response to the financial crisis.

Quantitative Easing

• Central banks expanded their balance sheets to boost the money supply via quantitative easing (QE) measures.
• Various countries introduced a variety of measures of QE.

Policy Reaction: International Cooperation

• There was a move to shift the importance from G7 to G20, including emerging markets, to coordinate responses.
• International cooperation and expanded IMF lending roles were important for fiscal stimulus.
• The Financial Stability Board assumed a key role to monitor and coordinate regulatory reform efforts.

Current Account Balances Today

• Global imbalances remain substantial.
• The US continues to have a current account deficit, while other nations had surpluses.
• There was pressure for policy changes in other countries' current accounts.

Lessons: How to Prevent Banking/Financial Crises

• For Banks: Regulation, reserve requirements, deposit insurance, division between investment and retail banking, robust regulatory oversight.
• For Governments: Prevent global imbalances that precipitate financial crises.
• For Both: Lenders of Last Resort (central banks, IMF).

Coronavirus: A Very Different Kind of Crisis

• The coronavirus crisis is presented as a different kind of crisis.

Economic Repercussions of the Coronavirus Pandemic

• Economic repercussions from the Covid-19 pandemic are noted.

Coronavirus = Supply and Demand-Side Shock

• The crisis is presented as an example of supply and demand-side shocks.
• Supply issues from factories and service closures, disrupted supply chains, and a surge in demand are notable examples observed during Covid-19.

Government Responses to Simultaneous Demand & Supply Shock

• Government strategies to contend with simultaneous supply and demand-side shocks are shown.

A Coronavirus-Specific Problem: Inflation

• A rise in global commodity prices and consumer demand shifts are associated with inflation during the coronavirus pandemic.
• Disruptions in supply chains, and unrelated energy price surges, added to inflation.

A Coronavirus-Specific Problem: Inflation (Continued)

• Supply chain issues make fixing inflation harder.
• Low interest rates can be ineffective in fixing supply issues.
• Increased demand as lockdowns end led to further inflationary issues.

The Policy Goal: A "Soft" Landing

• The policy goal is to bring down inflation without causing a recession.
• The interest rate increases were a tool in addressing the situation.

Core Takeaways

• Global imbalances contribute to financial and currency crises.
• Economic activity is highly interconnected given globalized capital flows.
• Fixed exchange rates are challenging to maintain when dealing with significant short-term capital flows.
• Crises are more complex to handle when supply-side shocks are evident, as seen during the pandemic.

Next: Trade in Energy, OPEC, and Climate Change

• This section sets up a study of energy trade, OPEC's involvement, and the effects of climate change.