International Monetary Fund December, 2012

Where We Are in the Global Crisis

Olivier Blanchard

World

U.S. Euro Area Japan Russia EMs LICs

2012

(October 2012) 3.3 2.2 -0.4 2.2 3.7 5.0 5.3

2012

(Revision from Jul 2012) -0.2 0.1 -0.1 -0.2 -0.3 -0.3 -0.2

2012

(Revision from Sep 2011) -0.7 0.4 -1.5 -0.1 -0.4 -0.9 -0.5

2013

(October 2012) 3.6 2.1 0.2 1.2 3.8 5.4 6.0

2013

(Revision from Jul 2012) -0.3 -0.1 -0.5 -0.3 -0.1 -0.3 0.1

2013

(Revision from Sep 2011) -0.8 -0.4 -1.4 -0.8 -0.2 -0.9 0.0

GDP Forecasts (percent change from a year earlier)

Note: EMs = emerging market economies; LICs = low income countries, as defined in World Economic Outlook (Chapter 4).

Source: IMF, World Economic Outlook.

EMs LICs

1

-3

-2

-1

0

1

2

3

Apr. 2010 Oct. 2010 Apr. 2011 Sep. 2011 Apr. 2012 Oct. 2012

France Italy Spain Germany

0

1

2

3

4

5

6

7

8

9

10

Apr. 2010 Oct. 2010 Apr. 2011 Sep. 2011 Apr. 2012 Oct. 2012

Brazil India China Russia

Looking More Closely: Euro Area and Major EMs (GDP growth in 2012: WEO forecasts, percent)

Source: IMF, World Economic Outlook.

Major EMs

2

Euro Area

The Challenge:

Achieving Fiscal Consolidation while Sustaining Growth in

Advanced Economies

-30

-20

-10

0

10

1915 1920 1925 1930

A Warning from the Past: UK after World War I

0

40

80

120

160

200

1915 1920 1925 1930

Government Debt (percent of GDP)

70

80

90

100

1915 1920 1925 1930

Real GDP (index; 1918 = 100)

Sources: Abbas and others (2010); Feinstein (1972); Mitchell (1998); and IMF, World Economic Outlook (Chapter 3).

Primary Budget Balance (percent of GDP)

3

Slow Growth in Advanced Economies

5

-30

-20

-10

0

10

20

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Employment during Financial Crises 1/ (percent change from pre-crisis peak; years from peak on x-axis)

Sources: SNL Financial; and IMF staff estimates.

1/ 1977 (Spain), 1991 (Finland , Norway, and Sweden), and 1997 (Japan).

Average of 5 most recent

advanced economy financial crises 1/

United States,

Great Depression

United States,

2008-09 financial crisis

6

Financial Crises Have Long Employment Tails

EM Slowdown

Three Brakes

Policies

One Accelerator

0

1

2

3

4

5

6

07 08 09 10 11 12

Federal Reserve Bank of Japan European Central Bank Bank of England

Sep.

2012

10/4

0

5

10

15

20

25

30

35

07 08 09 10 11 12

Accelerator: Monetary Policies

Sources: Bloomberg, L.P.; Haver Analytics; and IMF staff calculations.

Central Bank Balance Sheet Expansion (percent of 2008 GDP)

Fed QE1 Fed QE2

Operation

Twist

Central Bank Policy Rates (basis points)

Fed QE1 Fed QE2

Operation

Twist

LTRO 1

LTRO 2

LTRO 1

LTRO 2

4

EM Slowdown

Three Brakes

Policies

One Accelerator

10

Brake 1. Fiscal Consolidation: A Long Road Change in Cyclically-Adjusted Primary Balances (percentage points of potential GDP)

Source: October 2012 Fiscal Monitor, and IMF staff estimates.

Note: Total required adjustment to reduce the gross debt ratio to 60 percent by 2030 (net debt target of 80 percent for Japan).

After 2020, primary balance constant until 2030. Assumed real interest rate-growth gap is model-based.

-2 0 2 4 6 8 10 12 14 16 18 20 22

Germany

Canada

Italy

France

Portugal

United Kingdom

United States

Spain

Ireland

Japan

Greece

Actual and Projected Adjustment (2010 - 2012) Remaining adjustment until 2020 to achieve illustrative debt targets

5

-8

-6

-4

-2

0

2

4

6

8

-4 -3 -2 -1 0 1 2 3 4 5 6

Large Multipliers

Growth Forecast Error vs. Fiscal Consolidation Forecast 1/

Source: IMF staff calculations.

1/ On vertical axis, figure reports cumulative growth of real GDP during 2010 and 2011, in percent, minus spring 2010 WEO forecast. On

horizontal axis, figure reports spring 2010 WEO forecast of the cumulative change in the structural fiscal balance in 2010 and 2011 in

percentage points of potential GDP.

Fiscal Consolidation Forecast

Gro

wth

Fo

reca

st

Err

or

Growth Forecast Error = 0.7 – 1.2 Fiscal Consolidation Forecast; R 2 = 0.51

(0.4) (0.2)

6

-40

-20

0

20

40

60

80

100

04 05 06 07 08 09 10 11 12

United Kingdom

Euro area

United States

12Q3

Bank Lending Conditions (net percentage of respondents tightening loan standards)

Tighter

lending

conditions

Sources: Lending surveys by the Bank of England, European Central Bank, and the U.S. Federal Reserve for households and corporates; and IMF staff estimates.

Brake 2. Financial Intermediation

12

0

1

2

3

4

5

6

7

8

2008 2009 2010 2011 2012

ECB France Germany Spain Greece Portugal Italy

Sources: Haver Analytics; and IMF staff calculations.

Aug. 12

Lending Rates

Euro Area Official and Bank Corporate Lending Rates (percent; three-month moving average)

7

0.5

1.0

1.5

2.0

2.5

2008 2009 2010 2011 2012

Policy Uncertainty

Implied Volatility 1/

Sep. 12

Brake 3. Uncertainty ?

Sources: Bloomberg, L.P.; Economic Policy Uncertainty; and IMF staff calculations.

1/ VIX for the United States and VSTOXX for the euro area.

United States (index; January 2008 = 1)

Lehman

Debt Ceiling

Fiscal Cliff

Euro Area (index; January 2008 = 1)

0.5

1.0

1.5

2.0

2.5

2008 2009 2010 2011 2012

Sep. 12

Lehman

Greek IMF program

request, rating cuts

Papandreou call

for referendum

8

EM Slowdown

Three Brakes

Policies

One Accelerator

-4

-3

-2

-1

0

1

2

3

-1.6 -1.4 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0 0.2

Un

exp

ec

ted

Gro

wth

(p

erc

en

t)

Unexpected AE Partner Growth (percent)

The EM Slowdown: Spillovers from AEs and More

Note: Unexpected growth denotes real GDP growth in 2012 (October 2012 WEO) minus the forecast (September 2011 WEO). Unexpected AE

partner growth denotes export-weighted average of growth of advanced-economy trading partners in 2012 minus the forecast for the same

period, multiplied by the economy’s 2011 share of exports in real GDP. Each data point indicates an economy in the WEO group of EMDEs.

Sources: IMF, World Economic Outlook; and IMF staff calculations.

Unexpected Growth = 0.1 + 1.8 AE Partner Unexpected Growth; R 2 = 0.25

(0.2) (0.3)

9

-300

-200

-100

0

100

200

-1000

-500

0

500

1000

2010 2011 2012

Equity Flows Bond Flows (RHS)

12/10

Russia

Source: EPFR Global.

Capital Flows to EMs: Volatility Dominates (millions of U.S. dollars; weekly flows)

10

-600

-400

-200

0

200

400

-400

-300

-200

-100

0

100

200

300

400

2010 2011 2012 12/10

Central and Eastern Europe

-1200-1000-800-600-400-2000200400600800

-6000

-4000

-2000

0

2000

4000

2010 2011 2012

Equity Flows Bond Flows (RHS)

12/10 -1500

-1000

-500

0

500

1000

1500

-2000

-1500

-1000

-500

0

500

1000

1500

2000

2500

2010 2011 2012

Equity Flows Bond Flows (RHS)

12/10

Emerging Asia Latin America

Risks: Feedback loops

Fiscal consolidation, Weak banks, Weak growth

18

Weaker banks Fiscal consolidation

Lower fiscal

balance

Lower bank

asset quality

Less bank

lending

Automatic

stabilizers

held back

Perceived

sovereign

risks increase

Lower growth

Higher

implicit

guarantees

Doubts

Rollover risks

Doubts

Rollover risks

19

EM Slowdown

Three Brakes

Policies

One Accelerator

Accelerator: Accommodative monetary policy; manage risks from low rates.

Advanced Economies: How to Maintain Growth?

Policies

12

Brake 1. Continue medium term, credible, fiscal consolidation. Structural targets.

Be ready…. Lame, but circumstances vary, both domestically and externally

Emerging Market and Developing Economies

Brake 2. Continue to repair the financial system.

Brake 3. Decrease policy uncertainty, US, Europe, Japan.

Diagnosis

Adverse asymmetric shocks can

be large.

Architecture Plans Being Laid (“Fiscal/Banking Union”)

Prescription

Policies. Focus on the Euro Area I

Banks amplify.

Limit shocks ex ante. Consider

transfer mechanisms ex post.

Bank regulation/ supervision/

resolution/recap. to euro level.

Lower sovereign default probability

and sovereign/bank links.

Sovereign/bank interactions

amplify further.

13

Adjustment Plans: Underway.

Countries Under Market Pressure

Direct recapitalization of banks: Soon ready to go (ESM) (?).

Ready to go (ECB OMT), if:

Policies. Focus on the Euro Area II

Focusing on the Short Run

Euro Area Level

“Reasonable” borrowing rates:

? Formal programs:

14