Several new items regarding assessing recoveries, here and abroad; and the prospects for rebalancing.
The IMF View, and the Recovery Compared
The IMF released its semi-annual World Economic Outlook on Tuesday, with an overview chapter reviewing the state of the world economy. One of the topics was a cross country comparison of this recovery against previous post-War recoveries. From Ayhan Kose, Prakash Loungani, and Marco Terrones, entitled “The Global Recovery: Where Do We Stand?”:
… the current recovery in advanced economies has been extremely weak, reflecting in part the legacy of the global financial crisis, particularly the ongoing need for balance sheet repair in the household and financial sectors.8
This paper analyzes the interactions between business and financial cycles using an extensive database of over 200 business and 700 financial cycles in 44 countries for the period 1960:1- 2007:4. Our results suggest that there are strong linkages between different phases of business and financial cycles. In particular, recessions associated with financial disruption episodes, notably house price busts, tend to be longer and deeper than other recessions. Conversely, recoveries associated with rapid growth in credit and house prices tend to be stronger. These findings emphasize the importance of developments in credit and housing markets for the real economy.
Then think of the results of Jordà, Schularick, and Taylor (2011), recounted in Tuesday’s post, and we see that if one wants to evaluate a recovery, one needs to condition appropriately. That is, if one is going to condition one’s expectations of a recovery on the extent of contraction during the recession, one should also condition on other factors. That lesson clearly still eludes many observers, for whatever reasons.
Prospects for Rebalancing
In a new e-book edited by Ulrich Volz, entitled Financial Stability in Emerging Markets I have an article assessing the prospects for global rebalancing. From “Global rebalancing with financial stability: possible, feasible, or unlikely?”:
The prospects for rebalancing are assessed here from the following perspective: the global economy was unbalanced before the financial crisis of 2008, with current account surpluses in China and the oil exporting countries matched by deficits primarily in the United States (US). While imbalances shrank during the period 2007–09, during the ensuing Great Recession, we can now see surpluses and deficits again expanding.
The source of these imbalances has been the topic of an extensive and heated debate that is far too complicated to recount here. I would argue that while intertemporal consumption smoothing and the dearth of profitable investment projects in East Asia are partly to blame, I think that the existence of distortions in domestic financial markets in the United States attracted excess savings from the rest of the world.3 The abdication of regulation on the part of the Bush Administration, aided and abetted by the anti-regulatory ethos of the Greenspan
Fed, ensured that the capital inflows that came with the current account deficit would manifest themselves in the form of a massive boom. The resulting bust in consumption led to a short-term improvement in the current account as imports fell faster than exports.
With the resumption of growth, there were hopes that global rebalancing would occur, that
is, that demand in China and East Asia would reorient itself away from exports and towards domestic consumption while US aggregate demand would shift towards tradable goods. It was never clear that the first part of the equation would occur, and it’s certainly clear that the second part is not occurring with sufficient rapidity to make an impact over the next couple of years.
At this juncture, I think it is useful to recount what our models can tell us. In work with
Barry Eichengreen and Hiro Ito, we have highlighted the fact that given projected growth rates, and the historical norms that have governed the behaviour of current account balances over the medium term, a persistence of current account balances can be predicted (cf. Chinn / Eichengreen / Ito 2011). On the other hand, it is also true that our models have done a poor job of predicting the level of current account balances for key countries like the US and China, especially during the 2006–08 period. That is, while budget balances explain some of the deterioration in the US current account, and the lack of both financial and institutional development explain some of the surpluses of China, movements of these factors do not enable us to track external developments in these economies.
In our forensic analysis, we found that the extent of misprediction during the 2006–08 period was well explained by housing price appreciation and private bond market growth during the preceding 5-year period. In addition, increasing leverage in the household sector was clearly associated in a subset of countries with a deterioration in current account imbalances. The unfolding of those trends – particularly in the United States, but also in the United Kingdom – may very well result in greater current account convergence than we predict with our statistical model.
For China, since our model is unable to capture the behaviour of Chinese surpluses during the 2000s, I’m particularly loathe to make predictions based solely on our statistical model. Suffice it to say that to date we have not seen evidence that the rapid internal rebalancing of China’s spending patterns is having an effect on substantial shrinkage in Chinese current account balances.
See here for the Chinn, Eichengreen and Ito paper. The policy prescriptions based upon this view of the world differ from the simplistic arguments often forwarded of deregulating the financial markets further.
The table of contents for the book:
- Global rebalancing with financial stability: possible, feasible, or unlikely?
Menzie D. Chinn
- US quantitative easing: spillover effects on emerging economies
- The comovement of international capital flows: evidence from a dynamic factor model
Marcel Förster / Markus Jorra / Peter Tillmann
- Global liquidity and commodity prices
- Foreign banks and financial stability: lessons from the Great Recession
Ralph de Haas
- Emerging market economies after the crisis: trapped by global liquidity?
- Capital account management: the Indian experience and its lessons
Y. Venugopal Reddy
- Avoiding capital flight to developing countries: a counter-cyclical approach
Stephany Griffith Jones / Kevin P. Gallagher
- What role for the FSB?
Jo Marie Griesgraber
- International capital flows and institutional investors
- Global liquidity and the Brazilian economy
- AMRO’s role in regional economic surveillance and promoting regional economic
and financial stability
Speaking about rebalancing, how should fiscal consolidation proceed? The recently released IMF Fiscal Monitor has an interesting finding (Appendix 1):
There is an extensive and—since the economic crisis— rapidly expanding empirical literature that tries to estimate fiscal multipliers. However, only a few empirical studies have so far analyzed the links between fiscal multipliers and the underlying state of the economy.
New research (Baum, Poplawski-Ribeiro, and Weber, 2012) finds that the position in the business cycle affects the impact of fiscal policy in G-7 economies: on average, government spending and revenue multipliers tend to be larger in downturns than in expansions. This
asymmetry has implications for the desirability of upfront fiscal adjustment versus a more gradual approach.
Figure from IMF Fiscal Monitor, April 2012.
This suggests that even if one’s objective were to shrink government discretionary defense and nondefense spending to 4% of GDP, as in Representative Ryan’s budget , it still might not make sense to front-load consolidation via government spending cuts.