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How the Financial Crisis Affects the Real Economy

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How the Financial Crisis Affects the Real Economy Powered By Docstoc
					The impact of the latest
economic turmoil on
European industry
Hearing at the European Parliament


Zsolt Darvas
10 November 2008



                                     1
          Big uncertainty about the future
                  IMF World Economic Outlook:
                  GDP growth forecasts for 2009
          6
          5
                                                                           world
                                                                                   Growth
          4
                                                                                   forecasts
          3                                                                US
                                                                                   for 2009
Percent




          2
                                                                           Euro    declined
          1                                                                area
                                                                                   sharply
          0                                                                UK

          -1                                                               CEE
          -2
               January




                                      July 2008




                                                              6 November
                                                  2 October
                         April 2008
                2008




                                                    20008


                                                                 20008




                                                                                           2
         60
              70
                   80
                        90
                             100
                                   110
                                         120
                                               130
                                                     140
jan.85
jan.86
jan.87
jan.88
jan.89
jan.90
jan.91
jan.92
jan.93
jan.94
jan.95
jan.96
jan.97
jan.98
jan.99
jan.00
jan.01
jan.02
jan.03
jan.04
                                         UK
                                         Italy




jan.05
                                         Spain
                                         France
                                                           Economic sentiment, Jan 1985 – Oct 2008

                                         Germany




jan.06
                                         Euro area




jan.07
jan.08
      Euro Area: Economic sentiment, Comparison of
      1990-1994 with 2007-2008
120

115                               Jan 1990 - Dec 1994
110
                                  Jan 2007- Oct 2008
105

100

95

90

85

80

75

70
      1990 & 2007




                    1991 & 2008




                                  1992 & 2009




                                                1993 & 2010




                                                              1994 & 2011
            Euro Area: Industrial confidence indicator,
            Comparison of 1990-1994 with 2007-2008
10

 5                                Jan 1990 - Dec 1994
 0
                                  Jan 2007- Oct 2008
 -5

-10

-15

-20

-25

-30

-35
      1990 & 2007




                    1991 & 2008




                                  1992 & 2009




                                                1993 & 2010




                                                              1994 & 2011
 Euro Area: Industrial production (% annual growth),
 Comparison of 1990-1994 with 2007-2008
8

6                                Jan 1990 - Dec 1994

4                                Jan 2007- Aug 2008
2

0

-2

-4

-6

-8
     1990 & 2007




                   1991 & 2008




                                 1992 & 2009




                                               1993 & 2010




                                                             1994 & 2011
Global financial turmoil

 Lot of stress /contagion / panic
  – Extreme preference for liquidity
  – Extreme volatility of stock, forex markets
  – Violent upward adjustment of risk premia
  – Major distortions in relative prices of financial
    assets


 Confidence shock strongly impacts the
  economy

                                                        7
Channels

Negatives
1. Wealth
2. Credit constraints
3. Access to liquidity, cost of capital and deleveraging
4. Financial turmoil in emerging world and falling
   global demand
Positives
1. Lower commodity prices
2. Lower inflation
3. Lower euro

                                                       8
 1. Wealth

 Negative shock to private sector wealth
  affects consumption, investment
 First-order issue in the US
  – Major decline in house and stock prices
  – Wealth-based consumption (mortgage equity withdrawals)
  – No-recourse mortgages vulnerable to negative equity
  – Pensions (defined contributions)
   Protracted adjustment of household sector is likely

 Less important in Europe
  – Equity ownership less widespread, PAYGO pensions regimes
  – Moderate decline in house prices (no decline in De, large in UK IE ES)
  – Weaker link with consumption
   Uneven effect within Europe                                         9
 2. Credit constraints
 Shock
  –   Negative initial shock to the asset side of bank balance sheets

 Financial multiplier
  –   Deteriorating balance sheets lead banks to lend less
  –   Deteriorating value of assets leads to further tightening of credit
  –   Amplified by dysfunctional interbank market

 Effect
  –   Lesser willingness to lend, credit constraints across the board
  –   Risk of vicious circle

 Responses
  –   Recapitalisation plans
  –   Guarantees
                                                                            10
3. Access to liquidity, cost of capital
and deleveraging

 Extreme preference for liquidity: difficult to
  get from outside
 Lower equity prices & higher corporate bond
  spreads  higher cost of new capital in
  comparison to existing stock
 Adjustment in balance sheet structures, lower
  investment, lower demand for credit
 Temporary overshooting (rush for liquidity)



                                                   11
4. Financial turmoil in emerging
world and falling global demand

 Contagion to emerging countries since
  end-September
  – Capital flow reversals
  – Sovereign spreads
  – Domestic credit markets
  – IMF programmes

 Effects on Europe
  – Trade exposure
  – Financial exposure

                                          12
The positives

 Reversal of commodity price shock
 Effects of lower inflation
  – Income transfer to households
  – Frees central bank from policy dilemma
 Lower euro


 However, the positives merely correspond to
  the correction of previous negative shocks


                                                13
  New member states of the EU

 Difficulties in external financing - risk of a sudden stop
  in capital inflows to countries
       having huge current account imbalances (Baltics, Bulgaria,
        Romania)
       in which government heavily rely on foreign financing
        (Hungary)
 Most of the banking system in the New Members states of
  the EU (NMS) are owned by European banks: these EU
  banks face liquidity problems at home
 Rising risk premium
 Tighter credit conditions
 Economic slowdown in major trading partners (Euro
  area)
           Three-month interbank offered interest rates,
           2 January – 4 November, 2008

          8.5                                           8.5             20                                          20
                    Lithuania    Bulgaria                                         Rom ania
          8.0       Es tonia     Poland                 8.0                       Hungary
                                                                        18                                          18
                    Euro area    Czech Rep.                                       Latvia
          7.5       Slovakia                            7.5                       Euro area
                                                                        16                                          16
          7.0                                           7.0
                                                                        14                                          14
          6.5                                           6.5
Percent




                                                              Percent
          6.0                                           6.0             12                                          12

          5.5                                           5.5
                                                                        10                                          10
          5.0                                           5.0
                                                                         8                                          8
          4.5                                           4.5
                                                                         6                                          6
          4.0                                           4.0

          3.5                                           3.5              4                                          4
          2008:01      2008:04    2008:07     2008:10                   2008:01       2008:04   2008:07   2008:10




    Note: the Romanian rate peaked at 49.81% on 20 October 2008, but for better readability of the right hand
    side panel the vertical axis has a 20% cut-off.
Thank You For Your Attention

     zsolt.darvas@bruegel.org
        www.bruegel.org




                                16

				
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