Introduction to the Course and Main Issues in the Global Economy

1
Introduction to the Courseand Main Issues in
the Global Economy 

• by  Nouriel Roubini
• Stern School of Business
• New York University 
• September 2017

2
International Macroeconomic Policy Theory and
Evidence from Recent Financial Crises

• We study macroeconomic developments growth,
  unemployment, consumption, investment, inflation,
  trade balances, exchange rates, etc.
• Macroeconomics is an international discipline as
  most economies are not closed but open to trade
  in goods, services, labor, capital, technology,
  information (globalization).
• Most countries are small open economies some
  (U.S.) are large open economies. The world
  economy is interdependent and interconnected
  thanks to globalization

3
International Macroeconomic Policy

• Macroeconomic developments depend on macro
  policies
• Conventional (the policy rate tool, the money
  supply) and unconventional monetary policy such
  as, ZIRP (Zero Interest Rate Policy), QE
  (Quantitative Easing), CE (credit easing), FG
  (Forward Guidance), Negative Interest Rates,
  Liquidity Support of Banks and Non-Banks
• Conventional (tax and government spending) and
  unconventional fiscal policy (bailouts and
  backstop of banks, households, corporations and
  other state guarantees for economic agents)

4
International Macroeconomic Policy

• Macroeconomic developments depend on macro
  policies
• Exchange rate policies choice of the exchange
  rate regime (fixed, flexible, etc.), forex
  intervention, capital controls
• Supervision and regulation of the banks and other
  financial sector intermediaries (capital
  regulation, liquidity regulation,
  macro-prudential supervision, counter-cyclical
  credit policy)
• International economic policies such as
  coordinated macro policies as well as
  international bailouts (by the IMF or the
  Troika) of countries or bail-in of countries
  (coercive restructuring of public and/or external
  debt)

5
The nexus between macro news, policy reactions
and markets/asset prices

• Macro Triangle macro developments/news, policy
  reaction, markets and asset prices
• Macro developments/news lead to policy reactions
• Those policy reactions affect the evolution of
  the macro variables
• Macro news and macro policies affect markets and
  asset prices (stocks, bonds, currencies,
  commodities, credit)
• Asset prices react to macro news and policy news,
  ie unexpected rather than expected changes.
• Asset price changes lead to policy reactions and
  affect macro variables (through wealth effects
  and price effects)

6
Theory and Evidence from Recent Financial Crises

• Financial crises have become more frequent and
  severe in both developed markets (DM) and
  emerging markets (EM)
• Recent developed markets crises
• US housing and sub-prime crisis in 2006-2008
• Global Financial Crisis (GFC) of 2008-2009
• Sovereign debt crises and economic crisis in the
  Eurozone (2010-2013) Greece, Ireland, Portugal,
  Spain, Italy, Cyprus, Slovenia. Grexit Risk.
• Brexit a shock rather than a crisis
• Recent emerging market crises
• Mexico (1994), East Asia (1997-98), Russia
  (1998), Brazil (1999), Turkey and Argentina
  (2001)
• EM mini-crisis in 2013-15 and Chinas 2015-16
  turmoil

7
Nature of Financial Crises

• There are many types of financial crises
• Currency crisis when a fixed exchange rate regime
  collapses or a currency goes into a free fall
• Balance of Payments (BoP) or external debt crisis
• Sovereign debt crisis
• Banking crisis
• Corporate debt crisis
• Household debt crisis
• Broad financial crisis that combines many
  elements of the above crises (Argentina 2001 for
  example)

8
Types of financial crises liquidity versus
solvency crises

• Financial Crises can be distinguished into two
  broad types
• Solvency crises
• Liquidity crises
• Insolvency An agent is insolvent when its debt
  relative to its income is so high that in most
  states of the world it will not be able to pay
  back its debt and the interest on it
  (unsustainable debt)
• Illiquidity An agent is solvent but illiquid
  when its debt is not unsustainable but it has
  large amounts of this debt coming to maturity
  (short term debt) and it is not able to roll it
  over (liquidity crisis, rollover/run crisis)

9
Liquidity versus Solvency Crises

• Many combinations of liquidity/illiquidity and
  solvency/insolvency
• Illiquidity can lead to insolvency as illiquidity
  can trigger default
• Illiquidity can be resolved via
• Domestic or international lender of last resort
  support (bailouts) to stop rollover/run crises
• Orderly but coercive restructuring (maturity
  extension) of debts (bail-in of creditors
  policies)
• Insolvency is resolved via
• Orderly debt restructuring before default
• Disorderly debt restructuring (default and debt
  reduction)

10
Course Structure

• Syllabus http//people.stern.nyu.edu/nroubini/MAC
  RO5.HTM
• Textbooks
• Reading List http//pages.stern.nyu.edu/nroubini
  /Readingl3.html
• Assignments http//people.stern.nyu.edu/nroubini/
  ASSIGN01x.HTM
• Requirements (assignments, mid-term exam, final
  exam)
• Other online and offline tools for the course

11
Current Global Economic Outlook and Uncertainties
(Known Unknowns)

• Former U.S. Defense Secretary spoke during the
  Iraq War of known knowns, known unknowns and
  unknown unknowns.
• Known unknowns are known risk/uncertainty factors
  that will materialize in the future in one way or
  another
• The world economy is characterized today by many
  known unknowns, for example which who will be
  the next Fed Chairman.

12
Known Unknowns Fed Chair

• Known Known Yellen first term expires at the
  beginning of 2018
• Known Unknown Who will be the next Fed Chairman?
  Yellen, Cohn, Warsh, Taylor, Hubbard, etc?
• Unknown unknown Would Trump choose someone
  highly incompetent as Fed Chair such a real
  economic populist? Unlikely

13
Known Unknown Economy, Tax policy and the Fed

• Will economic growth finally accelerate above
  potential?
• Will wage and price inflation remain contained or
  accelerate?
• Is the US in a secular stagnation with low
  potential growth?
• Will Congress pass tax reform this year?
• Will the next Fed Chair me more or less dovish
  than Yellen?

14
Known Unknown Fed Policy Normalization

• When will the Fed hike again?
• In December 2017
• Not in December 2017
• How many times will the Fed hike rates in 2018?
  Three times as the dots suggest or less as the
  market predicts?
• When will the Fed finish normalizing the policy
  rate to a neutral level and what this level will
  be (2, 2.75, or 3 or 4, etc)?
• What could stop the Fed from running down its
  balance sheet?

15
Known Unknown U.S. Fall Fiscal Fistfights

• Fiscal known unknowns in 2017-18 in the U.S.
• Which will be the fiscal policies of Trump?
• Will Republicans start another fight on the debt
  ceiling as in 2013?
• Will there be a government shutdown in December?
• Will Congress pass tax reform this year and what
  will be the new corporate tax rate compared to
  todays 35?

16
Macro and market implications of these known
unknowns

• The resolution of these known unknowns (growth
  and inflation, Fed policy rate normalization
  pace, U.S. fiscal policy) will affect
• The real economy through demand and confidence
  (consumer, business) effects
• The financial markets and asset prices in the
  U.S. and globally bond yields, stock market,
  credit spreads, U.S. credit rating, U.S. dollar
  value, commodities, emerging markets.

17
Current Known Unknowns in the Global Economy

• U.S. economic, political, geopolitical, monetary,
  fiscal and trade uncertainties given the Trump
  administration
• Prospects for growth in developed markets (DM
  US, Europe, Japan, etc.) and emerging markets
  (EM)
• Will DM return to strong growth or will the
  recovery remain anemic and sub-par? Expansion or
  Slowdown?
• Is the recent slowdown in EM cyclical or
  structural?
• Will some EM experience a full crisis and which
  ones are most at risk?
• China hard or soft or bumpy landing?
• Will oil/commodity prices go higher or lower?

18
Current Known UnknownsBrexit and
EU-Disintegration

• Will the UK truly exit the EU or eventually
  back-pedal?
• Which deal between UK and EU if Brexit occurs?
  How much of a loss of market access for the UK?
  Soft or Hard Brexit?
• Will the EU/Eurozone continue to integrate or
  will gradually dis-integrate over time?
• Which are the main political risks in the EU
  Italy, Greece, and now Germany?
• Will Germany accept greater EZ integration and
  risk sharing or will bailout fatigue dominate?
• Will the migration crisis be contained or widen
  so as to threaten the free borders within the EU
  (the Schengen agreement)?

19
Current Known Unknowns in the Global Economy
Eurozone

• Will the recovery of growth in the Eurozone be
  robust or weak/anemic/uneven?
• Is the EZ still at risk of deflation?
• Will anti-Euro parties win the 2018 Italian
  elections?
• How fast will the ECB taper its QE and for how
  long it will keep negative policy rates?
• Will EZ fiscal policy become more flexible?
• Will structural reforms accelerate and where?
• Will the Euro currency value rise or fall?

20
Current Known Unknowns in the Global Economy
Japan

• Will Abenomics work in Japan?
• Stronger growth and inflation increase or
  relapse?
• Will structural reforms and trade liberalization
  be implemented?
• Will Abe win the snap elections?
• Will the BoJ do additional QE in 2018 and go more
  negative with it policy rates?
• What is the risk of a public debt crisis in the
  next few years? When will the VAT be raised?
• Will the Yen weaken and equities rally?

21
Current Known Unknowns in the Global Economy
China

• Will Xi try stay in power more than 10 years?
• Will China experience a soft landing or a hard
  landing or a bumpy?
• Will China rebalance growth away from too much
  savings, investment and exports towards
  consumption and labor intensive growth?
• Which structural reforms will be implemented in
  2018 and beyond after the Party Congress?
• Will China do another round of policy easing if
  growth slows again or accept lower growth?
• Will the RMB and stock market rally or fall?

22
Current Known Unknowns in the Global Economy EM

• Is the recent slowdown of EM growth in 2013-16
  cyclical or structural? What are its causes?
• Will financial pressures intensify to the point
  of a crisis in some EM or will they diminish?
• Which EM are most at risk and why?
• What policy options are available for these EM at
  risk?
• What are the medium term prospects for the BRICS
  and other EM?
• How robust and resilient is the recovery of EM
  growth and markets since mid 2016?

23
Current Known Unknowns in the World
Geopolitical Risks

• US and the Trump political/geopolitical
  uncertainties
• Is a military conflict with North Korea likely?
• Will the Russia-Ukraine conflict escalate or not?
• Syria-Iraq-ISIS further destabilization or
  stabilization?
• Political risks in Europe in Italy, Greece,
  Germany, etc
• Asian territorial issues (as in the case of
  Japan-China dispute on some islands)
• Geo-political implications of the rise of China
  peaceful rise?
• Which other unknown unknowns (like a 9/11 event
  or other terrorist attacks)?
• Will markets keep on ignoring geopolitical risks
  and why?
• Populist backlash against globalization, trade,
  migration, supra-national authorities,
  technological disruption.
• Rise of income/wealth inequality feeds populism

24
Current known unknowns Global Tail Risk Episodes

• Three episodes of global tail risk in the last
  year summer 2015, Jan-Feb 2016, post-Brexit
  short term volatility
• Will another one occur this year or next?
• What will trigger it?
• Would the market correction be reversed or lead
  to a full bear market?
• What could reverse the correction central bank
  policies or better fundamentals?

25
Current known unknowns Unconventional monetary
policies

• In the last decade very unconventional monetary
  policies in advanced economies that didnt even
  exist before (ZIRP, QE, CE, FG, NIRP)
• Will these policies continue or phased out and
  how fast?
• Are these policies desirable or having unintended
  consequences and costs?
• Will they eventually cause inflation or
  deflation/lowflation remain more likely?
• What will central banks do during the next
  recession?
• Will the baton be passed from monetary to fiscal
  policy?
• Which policies for Fed, ECB, BoJ, BoE, PBoC, SNB?

26
Current state of the global economy

• New Mediocre (IMF) New Normal (China, PIMCO),
  Secular Stagnation (Larry Summers), Great
  Deleveraging (Ray Dalio), New Abnormal (Roubini)
• Lower potential growth in developed markets (DM)
  and emerging markets (EM)
• Till recently actual growth below potential in DM
  EM
• Low productivity growth in DM productivity
  puzzle in spite of technological innovations
• Global economy swinging between periods of
  Acceleration (positive growth that is increasing)
  and Slowdown (positive growth that is slowing
  down)
• Since mid 2016 we have global acceleration/expansi
  on led by accommodative policies and better
  confidence

27
Mystery of the missing inflation

• In spite of stronger growth in DM inflation is
  still low if not falling relative to a 2 target.
  This is odd if stronger growth comes from
  stronger aggregate demand
• So, maybe supply shocks (temporary or permanent)
  keep inflation low
• Globalization
• Weaker workers and unions
• More competition
• Technological innovations
• Still low oil and commodity prices
• Temporary factors
• What should be the central banks response to
  this inflation shortfall? Keep on normalizing
  policy as labor market is tighter or try to fight
  the low inflation?
• Answer depends on whether the shocks are
  temporary or permanent
• But even if the shocks are permanent, some
  believe that policy normalization should continue
  as there is the risk of financial instability
  (asset and credit bubbles)

28
Causes of lower potential growth

• Demographics ageing in DM and EM
• High debt ratios that slow spending
• Fall in corporate capital spending (global
  investment slump)
• Hysteresis the cycle affects the trend
• Rise in income/wealth inequality
• Slow structural reforms
• Persistent global savings glut

29
Causes of actual growth below potential

• Great deleveraging high private and public debt
  and deficits first US/UK, then Europe/Eurozone,
  now emerging markets
• Wrong policy mix too much monetary policy, too
  little fiscal policy
• Asymmetric adjustment between creditors/savers
  and debtors/borrowers in a way that creates a
  global savings glut and a global investment slump

30
Explanations of the low productivity puzzle

• Technological pessimism (Gordon)
• Ongoing deleveraging (Rogoff)
• Lag between innovations and their spread from
  tech to other sectors (B2B, B2C)
• Mismeasurement of productivity as many
  goods/services/apps are free and as true prices
  of software is not properly measured
• Firms that shed work after the GFC are ramping up
  hiring now for a while
• Low skills and human capital of many workers who
  are not prepared for this globalized digital
  economy

31
Trump policies

• Trumps election led initially to a rally in US
  equities, a rise in long rates and the dollar
  based on expectations that his policies (tax
  cuts, infrastructure spending, deregulation) will
  lead to higher growth and more profits for the
  corporate sector
• But some of his policies may hurt economic growth
  (protectionism, restrictions to migration,
  micro-managing the corporate sector, excessive
  fiscal stimulus)
• Markets overestimated initially the potential
  positives and underestimated the negatives.
• Now a market re-assessment fixed income and
  currency markets are now more skeptical about the
  stimulus and the rise in US growth
• While the stock market is still moving higher as
  his expected policies appear to be supportive of
  the business and corporate sector.
• But US equity valuations may be stretched (based
  on the Shiller CAPE criterion)

32
The global economy after the global financial
crisis (GFC)

• The economic recovery after the GFC was
  two-speed
• Anemic, sub-par, below trend in DM (US, EZ, UK,
  Japan) U-shaped
• Strong with return to potential or above trend in
  most EM V-shaped
• Why V-shaped in EM?
• Less balance sheet problems of too much private
  and public debts. Cleanup after EM crises of the
  1990s
• Higher potential growth (5 in EM vs 1-2 in DM)
• More room for policy response

33
Why U-shaped Recovery in DM?

• The 2008-09 crisis was not a plain vanilla
  recession
• It was a recession caused by a financial crisis.
  And a financial crisis caused initially by too
  much debt and leverage in the private sector
  (households, banks and some corporates) and then
  during the crisis by a surge in public debt and
  deficits
• History and theory suggests that recovery from
  balance sheet crises is anemic for up to a
  decade you need to spend less and save more
  (dissave less) to reduce debt and leverage over
  time. Thus, an anemic recovery.
• Actually, a double dip recession in some DM (EZ,
  UK, Japan)

34
How did we avoid a Great Depression 2.0?

• During the GFC (btw the collapse of Lehman and
  mid-2009) global economic activity was falling at
  a speed similar to the beginning of the Great
  Depression
• The Great Recession of 2008-09 could have ended
  up into Great Depression 2.0.
• What avoided that? Learning the lessons of the
  Great Depression and avoiding policy mistakes
• Large conventional/unconventional monetary easing
• Massive fiscal stimulus for a while
• Backstop and bailout of the private sector
  (financial system, households, corporations)

35
Side effects of the massive policy response
during the GFC

• The massive monetary/fiscal/bailout response
  during the GFC was necessary to avoid another
  depression
• But it has led to lingering problems
• How to exit from ZIRP, QE, CE, FG?
• How and how fast to reduce fiscal deficits and
  debts that may be unsustainable?
• How to deal with the moral hazard that bailouts
  have induced?

36
Do you want to be Keynesian or Austrian following
a financial crisis?

• Keynesian approach provide monetary fiscal
  stimulus and bailout the private sector as
  otherwise the recession can lead to a depression
  as self-fulfilling panics and runs occur while
  private demand is collapsing
• Austrian approach (Austerian) front-load the
  adjustment/reform and restructure balance sheets
  and PLs. Dont bailout as you postpone financial
  and operational restructuring and you cause moral
  hazard zombie banks, households, governments
• Austrian approach was tried in the 1930s (no
  monetary/fiscal stimulus and allow banks to
  collapse) and led to Great Depression. Liquidate
  liquidate!
• Bernanke learned the lessons of the Great
  Depression

37
Do you want to be Keynesian or Austrian following
a financial crisis?

• In the short run you want to be Keynesian as you
  want to avoid panic, animal spirits, runs and
  illiquidity to lead to a collapse of the private
  sector. Public demand has to substitute for
  collapsing private demand. Rescue illiquid but
  solvent agents.
• In the medium-long term you want to be more
  Austrian and do true economic and financial
  restructuring as, otherwise, you can zombify the
  economy and reduce long term growth
• Are problems of illiquidity or insolvency?

38
These debates Keynesian vs Austrian- are still
ongoing today

• Growth versus austerity debate
• Front load fiscal austerity (as in EZ and UK) or
  back load it (US, Japan)?
• Be very aggressive in monetary easing (US and
  Japan) or less aggressive (UK, EZ)?
• Bailout banks and recapitalize them fast (US) or
  go slow (EZ, UK)?

39
Empirical evidence on appropriate policy response

• US avoided a double dip recession and is growing
  at a 2 rate (output above pre-crisis level).
  Now even Japan is growing better
• UK grew more strongly after anemic recovery
• EZ had a double dip recession and is now weakly
  growingGDP still close to pre-crisis level
• What explains this relative performance?
• Relative monetary easing stronger in US/Japan/UK
• Front load or back load of fiscal consolidation
• Backstopping the financial system and
  recapitalizing the banks early on to avoid a
  severe credit crunch

40
Recent Reversal of DM vs EM Growth Fortunes

• In 2010-2012 slow, anemic growth in DM
  (U-shaped), strong growth in EM (V-shaped)
• In 2013-16
• Signs of somewhat stronger growth in DM (US, UK,
  less so in EZ and Japan)
• Sharp slowdown of growth in EM and financial
  pressures on EM markets

41
Why growth is recovering in DM?

• Deleveraging of private and public sector balance
  sheets has been ongoing for 7 years.
• New rounds of unconventional monetary policies in
  the U.S., Japan (QE and FG) and even in the EZ
  and UK (QE, CE and FG)
• Bailouts of banks and sovereigns in the EZ
  avoided a worse crisis and EZ break-up.
• Global tail risks are now lower
• The massive monetary stimulus has led to asset
  reflation (equity, housing, lower bond yields)
  that boosts confidence and increases demand

42
Why DM recovery could remain uneven?

• Deleveraging not over as debt ratios remain high
• Slow structural reforms
• Risk of a secular stagnation
• Easy monetary policies are becoming less
  effective and some are phased out
• Lack of proper fiscal policy stimulus
• Policy, political and regulatory uncertainties

43
DM outlook

• Differential in growth rates are now lower
  between US, EU, Japan and UK
• Inflation below 2 target in DM given still
  slack in goods and labor markets
• But inflation weaker in EZ and Japan relative to
  US/UK given differential growth recovery
• Risk of asset/credit inflation/bubbles?
• Exit from zero rates faster in US/UK than in
  EZ/Japan where QE continues

44
Why slowdown of Growth in EM and Financial
Pressures?

• Strong growth in EM in the last decade
  (2003-2013) was due to structural factors and
  cyclical/luck ones
• Structural
• 1st generation structural reforms (trade
  liberalization, openness to FDI, privatizations,
  opening of the economy)
• Sounder monetary and fiscal policy and stronger
  balance sheets after the EM crises of the 1990s
• Cyclical
• China boom (10-11 growth)
• Commodity super-cycle (partly because of China)
• Super-easy monetary policies in DM after 2009.
  Zero rates and wall liquidity searching for yield

45
Why slowdown of Growth in EM and Financial
Pressures?

• Why slowdown in 2013-16 then?
• 2nd generation reforms did not occur (micro ones
  that increase competition and productivity)
• Move away from market oriented policies towards
  state capitalism
• Some laxity in monetary and fiscal policy as
  liquidity was abundant, interest rates too low
  and credit excesses
• End of luck as
• China is slowing and becoming less resource
  oriented
• The commodity super-cycle is over
• However, gradually the Fed is exiting 0 rates.
  US bond yields up from 1.6 to 2.9 after May
  2013 taper tantrum

46
Which EM will suffer the most?

• Some EM have stronger macro, financial and policy
  fundamentals and some have weaker ones
• Weaker ones include countries with large current
  account deficits, large fiscal deficits, falling
  growth, commodity exporters, rising inflation,
  socio-political protest and upcoming elections
• Weaker group includes the Fragile Five India,
  Indonesia, Brazil, Turkey, South Africa
• Other fragile EM include China, Russia,
  Argentina, Venezuela, Malaysia, Ukraine

47
Will some EM experience a severe financial crisis?

• Compared to the past even the weaker EM (fragile
  five) have some positives
• Flexible exchange rates rather than fixed ones
  that could collapse
• A war chest of forex reserves to avoid liquidity
  runs on banks, currencies and governments
• Less currency mismatches and liability
  dollarization
• Lower private/public/external deficits and debts
  less solvency risk
• Better regulated banks and financial systems

48
Will some EM experience a severe financial crisis?

• But the weaker EM have some negative risks
• Ugly policy dilemma
• If you tighten monetary policy to avoid currency
  free fall and inflation, you kill growth and
  damage banks/corporations. So tight money is not
  credible.
• If you loosen monetary policy to boost growth,
  there is the risk of an inflationary free fall of
  the currency and risk that foreigners will not
  finance your external deficit. If you thus loosen
  monetary policy you may lose the nominal anchor
  of the economy and thus cause a free fall
• So damned if you do and damned if you dont.

49
Fragile EM in 2014-16

• Jan-Feb 2014 EM pressures Argentina, Turkey,
  Thailand politics and China scare
• Market pressure abated after February 2014 as
  many fragile EM tightened monetary, credit and
  fiscal policy. Markets rally that year.
• But macro and structural adjustment was still
  partial in fragile EM
• New bout of severe EM volatility in EM in
  spring-summer 2015 as China hard landing risk
  rose and led to a fall in commodity prices while
  the Fed was signaling exit from ZIRP

50
Medium term optimism for EM in spite of short run
pressures

• Medium term positive trends in EM
• Urbanization
• Industrialization
• Population growth
• Per capita income growth
• Rise of middle classes and consumer society
• A larger share of global GDP and growth in EM
• High potential growth given by
• Demographic dividend (high population growth)
• 2nd generation reforms will boost competition and
  productivity
• Ability to absorb existing and new technologies
  developed in DM
• Technological innovation in some EM (Korea,
  China, India, etc)

51
Will the DM recovery soon lift the growth in EM?

• Optimistic viewpoint the strong recovery of DM
  growth will soon lift via trade channels the
  growth rate of EM (recoupling)
• Three reasons to be partially skeptic
• The recovery of most DM will be somewhat anemic
  (EZ, Japan, US, UK).
• EM have some fundamental macro and structural
  problems that will take time to resolve. So DM
  and EM may decouple
• If the DM recovery will be stronger the Fed may
  exit zero rates faster and that will hurt the
  weaker EM while benefitting the stronger ones via
  trade links

52
US growth is improving in 2017 after a rocky
start

• U.S. economy is in a tentative improvement growth
  acceleration
• After a weak Q1, Q2 growth seems stronger (3)
• Latest data on GDP, labor market, consumption,
  investment, net exports are better if mixed
• Unemployment rate falling because of fall in
  labor force participation rate and stronger job
  creation
• Fiscal drag is modest now
• The rise in long rates in 2013 given taper talk
  crimped growth of interest sensitive sectors
  (housing, capex) but in 2014-17 long rates have
  fallen. Why?

53
Causes of US growth acceleration

• More advanced deleveraging, easy Fed policies,
  positive asset reflation, less global tail risks
• Shale gas and oil revolution
• Re-shoring of energy intensive manufacturing
• Stronger labor market with job creation
• Strong PL and balance sheet of corporate sector
  and banks

54
Some lingering US risks

• Structural reforms are not occurring
• Gridlock in Congress and partisanship
• Trump political and policy uncertainties
• Some households and young are still fragile
  income-wise and debt-wise
• Could inflation rear its ugly head?
• Implications of the rise in inequality
• Can economy sustain the rise in short long
  rates as the Fed exits debt ratios are still
  high?
• Risk of credit/asset bubbles as Fed exit is slow.
  Will macro-pru work?

55
The Macro-Pru Debate

• After GFC central banks care both about economic
  stability (strong growth with low inflation) and
  financial stability
• Easy money justified by slow recovery has led to
  asset reflation that can end up in asset bubbles
• Fed view two targets and two instruments
  monetary policy for economic stability and macro
  pru for financial stability/avoiding bubbles
• But macro-pru may not work as untested and hasnt
  worked in the past only instrument that enters
  in all cracks of the financial system is the
  interest rate instrument
• If macro pru doesnt work damn if you do and
  damn if you dont as
• Slow exit given weak recovery could cause the
  mother of all boom/bubbles that will eventually
  go into a bust/crush
• OR
• If macro pru doesnt work and monetary policy is
  then used to prick the bubble risk of a bond
  market rout and hard landing of the real economy

56
Eurozone outlook less tail risks but fundamental
problems unresolved

• The recovery of the EZ after the GFC was weaker
  than in the US given weaker policy stimulus
• The EZ relapsed in a double dip recession in
  2011-2013
• The periphery of the EZ entered a severe
  financial crisis with serious sovereign risks.
  Seven countries in trouble and five bailed out
  (Greece, Ireland, Portugal, Spain, Cyprus)
• Problems were initially in the private sector in
  Spain and Ireland in the public sector in
  Greece, Portugal and Italy
• Doom loop between the EZ banks and the sovereigns
• At the peak of the crisis in summer of 2012 risk
  of Grexit, EZ break-up, loss of market access by
  Italy and Spain

57
EZ tail risks are lower today

• EZ tail risks are lower today thanks to
• Draghis whatever it takes committment
• OMT program
• ESM fund on top of EFSF and EFSM
• Beginning of a banking and fiscal union
• Start of ECB QE in 2015 and then NIRP
• Germany realizing that EZ is also a political
  project that requires patience avoid Grexit
• Austerity and reforms supported by bailout funds,
  both fiscal and monetary (ECB)

58
Some Positives in the EZ Today

• Return to growth even if recovery is
  anemic/uneven
• ECBs QE, NIRP and Credit Easing lower euro,
  lower long rates, higher stock prices lower oil
  price since 2015
• A lot of fiscal adjustment is done and less
  fiscal drag ahead. EU accepted fiscal flexibility
• Beginning of structural reforms in periphery
• Internal devaluation (fall in Unit Labor Costs to
  increase competitiveness) in some periphery
• Austerity/reforms in exchange of liquidity and
  bailout funds holding politically.

59
The Negatives in the EZ

• Low potential growth given slow reforms
• Recovery after recession is fragile/weak/uneven.
• Public and private debts are still high and
  rising. Debt sustainability issue
• Loss of competitiveness has not been fully
  reversed. Improvement in trade balances is partly
  cyclical (recession)
• Still recovery of credit after credit crunch
• Still fiscal drag even if if diminished
• Political risks given rise of populism

60
The Negatives in the EZ

• EZ is still at risk of near deflation
• A monetary union requires a banking, fiscal,
  economic and political union to be viable in the
  long run
• Some limited progress on the banking union
• Austerity fatigue in the periphery and bailout
  fatigue in the core
• Political risks in core periphery still
  significant
• ECB only game in town as fiscal policy is
  constrained
• Brexit contagion to EU integration?

61
Draghinomics looks like Abenomics

• Draghi Slow growth depends also on aggregate
  demand not only on supply constraints (slow
  reforms)
• Three arrows QE and CE fiscal stimulus in short
  run with continued medium term consolidation
  structural reforms
• ECB does its share QE, NIRP and CE
• The fiscal stance will remain too restrictive
• Asymmetric adjustment of EZ continues
• Structural reforms are too slow

62
Abenomics is only partially working in Japan but
many risks remain

• Abenomics has partially worked
• Deflation ending
• Growth picking up
• Yen weaker and stock market stronger
• Open issues
• Will Abe win the snap elections?
• Will structural reforms and trade liberalization
  that increase potential growth be implemented
  faster?
• The rise of the consumption tax in 2014 led to Q2
  negative growth now the 2017 hike has been
  delayed
• Is Japans public debt sustainable in the long
  run?
• For how long will the BoJ continue its QE and
  NIRP policies?

63
China Hard landing or soft landing?

• Will China experience a soft landing or hard
  landing or a bumpy/rough landing?
• Chinas growth is unbalanced/unsustainable too
  much savings, investment exports too little
  consumption
• Will the structural reforms be implemented fast
  enough after the Party Congress to rebalance
  growth?
• Reforms are slower than optimal and desirable as
  leadership is divided and resistance to change
• Will the stock market and RMB crack again?
• Growth may slow down to 5 by the end of the
  decade given lower trend growth
• Will Prez Xi try to stay in power longer than 10
  years?

64
Major Es in the global economy The 2010-2016
period

• Economy
• Energy and oil prices
• Exchange rates and external imbalances
• Euro/Eurozone/ECB
• Emerging Markets
• East as Middle East
• East as East Asia
• Earnings/Equity markets

65
Economy (global) during the Global Financial
Crisis (GFC)

• The US and the global economy experienced in
  2008-2009 their worst recession in decades
• The housing and mortgage bust led to an economy
  wide recession in the US as there were spillovers
  of the housing recession to other sectors of the
  economy (autos, manufacturing, consumer durables)
• The liquidity and credit crunch that started in
  the sub-prime mortgage market spread to all
  credit and financial markets as this was not just
  a sub-prime problem sub-prime, near prime and
  prime mortgages, commercial real estate
  mortgages, credit cards, auto loans, student
  loans, leveraged loans
• Also the US consumers (consumption is 70 of
  aggregate demand) were shopped-out, saving-less
  and debt-burdened

66
Economy (in the GFC)

• This was both a liquidity crunch and a credit
  crunch the driven by serious solvency problems
  given over-leverage of households, financial
  institutions and parts of the corporate sector
• The myth that the rest of the world could
  decouple from the US recession was shattered in
  2008 there was massive re-coupling first in
  financial markets and then in the real economy.
  Recession in most advanced economies (US,
  Eurozone, Japan) recession or massive growth
  slowdown in emerging market economies)
• The Great Recession of 2008-09 bottomed out in
  late 2009 when most economies started to recover.
  But the recovery in DM since then was been
  anemic, sub-par, below trend, a U-shaped
  recovery. Stronger in 2016 as deleveraging more
  advanced?

67
Causes of the housing/credit bubble and
bust/crisis

• Easy monetary policy (the Fed tightened too
  little too late)
• Lax supervision and regulation of the financial
  system
• Excessive risk taking and leverage of the
  financial sector given distorted incentives
• Global current account imbalances and global
  savings glut
• Irrational exuberance and animal spirits leading
  to bubbles
• Government subsidization of housing (tax
  benefits, role of Fannie and Freddie, Community
  Reinvestment Act)
• Distorted incentives of rating agencies

68
Energy

• US/global recessions have been associated with
  oil price spikes (1973-74, 1979-80, 1990-91,
  2000-2001).
• In 2008 oil prices spiked again. This increase in
  oil prices was not driven by economic
  fundamentals but, in part, by speculation
• The high oil prices were one of the factors that
  triggered the global recession as they
  represented a negative terms of trade and real
  disposable income shock for oil importing
  economies (US, Eurozone, Japan, China, etc.)
• Once the global recession emerged oil, energy,
  commodity prices collapsed (oil down to 30).
• Later oil prices recovered and till 2013 they
  were around 100 as the global recovered.
• But in 2014-15 oil prices crashed given supply
  shock (shale revolution) and weak demand
• Impact of low oil on growth and inflation

69
Exchange rates and External imbalances

• The strength of the U.S. in the 1990s relative to
  Euro, Yen and other currencies led to a large a
  growing current account deficit in the US as the
  US lost competitiveness
• After 2000, the US current account deficit
  worsened further as the fiscal deficits
  mushroomed (twin deficits) and as the private
  savings rate sank close to zero
• This led to the debate on whether this current
  account deficit was sustainable or was going to
  lead to a crash in the value of the US dollar
  and/or a spike in US interest rates (dollar hard
  landing)?
• The dollar started to decline in 2002-2004,
  especially relative to the Euro, but then it
  sharply appreciated again in 2005 as interest
  rates and real growth differentials favored the
  relative to the euro and the yen.
• But the dollar resumed its fall in 2006-07 when
  the US had a growth slump, a financial crisis,
  and the Fed cut the Fed Funds rate starting in
  the fall of 2007

70
Exchanges rates and External imbalances

• The global current account imbalances were one of
  the causes of the global financial crisis
• The dollar started to appreciate during the
  financial crisis of 2008 as panicked investors
  were seeking the safety of dollar assets. When
  risk is off the dollar goes up
• The US trade deficit also started to shrink as
  the fall in consumption led to a fall in imports.
  But was this improvement mostly cyclical or
  structural? Is shale gas a game changer for the
  U.S. external balance?
• The risk of a dollar crash if foreign investors
  who financed the US twin deficit became
  concerned about the sustainability of such
  deficits is now lower as the US twin deficits
  have been shrinking
• The dollar rose rapidly since mid 2014 as growth
  recovered and the Fed is expected to exit ZIRP.
  Impact on growth and inflation
• But since the election of Trump the dollar has
  weakened

71
Europe/Euro/ECB (2000-2012)

• Growth was sluggish in Europe in the 1990s
  relative to the U.S. given structural impediments
  to growth
• Recovery of European growth after 2005
• The Euro showed significant weakness relative to
  the US dollar until mid 2002 as the Eurozone
  growth was weaker than US growth.
• The Euro then sharply appreciated until the end
  of 2004 (by about 40), and again in 2006-07
  (after a brief dollar rally in 2005)
• During 2008 not only Europe did not decouple from
  the US crisis but the recession in the Eurozone
  was more severe than in the US
• This was in part due to the fact that the policy
  easing in Europe (monetary and fiscal) was not as
  aggressive as in the US

72
Europe/Euro/ECB

• Fiscal stimulus in Eurozone was weaker because
  many of the member countries start from large
  fiscal deficits, large stocks of public debt and
  banks that are too big to fail and too big to be
  saved
• ECB easing during and after the GFC was weaker
  than the one of the Fed as the ECB has a single
  mandate of price stability.
• The recovery of growth in the EZ was even more
  anemic than the one of the US given less easy
  monetary policy, early fiscal tightening and
  unresolved bank problems
• Sovereign debt problems in the EZ and the EZ
  crisis
• Potential growth for the Eurozone is low 0 to
  1.5 in the periphery - and possibly falling
  because of structural rigidities. EZ at risk of
  near deflation now.
• What are the prospects for structural reforms in
  Europe?
• Will the recent EZ growth pick-up since 2016
  continue?

73
Emerging market economies (2000-2013)

• Emerging market (EM) economies experienced many
  economic and financial crises in the 1994-2002
  period
• 2001 was a dismal year for emerging market (EM)
  economies. The slowdown of growth in US and G7,
  the tech bust and the reduction of flows of
  capital to emerging markets led to a sharp
  slowdown of growth in many emerging markets.
• Outright currency and financial crises emerged in
  Turkey (February 2001) and Argentina (December
  2001). In 2002, severe pressures mounted in
  Uruguay and Brazil Uruguay experienced a severe
  financial crisis in 2002 Brazil barely escaped a
  financial crisis as elections loomed in late 2002
  but then it recovered after Lula followed
  moderate policies.

74
Emerging market economies

• Emerging market (EM) economies growth recovered
  sharply in 2004, especially in Asia but also in
  Latin America. Important role of macro and
  financial reforms after the EM crises in this
  growth recovery
• 2004-2007 were excellent years for EMs as global
  conditions were ideal global growth was high,
  global interest rates were low, commodity prices
  were high and global investors risk aversion low
  (search for yield).
• The financial crisis to a massive re-coupling
  financial and real - of emerging markets with
  advanced economies many emerging markets entered
  a recession and others had a massive growth
  slowdown.
• Financial and economic crises in Emerging Europe
• The recovery of growth in some emerging markets
  China, India, some other parts of Asia, Brazil
  and parts of Latin America was earlier and
  faster than advanced economies as their macro and
  financial fundamentals are robust. A V-shaped
  recovery
• But in 2013-15 many EM faced slowdown.
• Recovery of growth and markets in EM since 2016.
  Resilient?

75
East as in Middle East

• Oil prices are low today given the shale
  revolution.
• But turmoil in the Middle East (the Syria and
  Iraq security situation the Arab Spring
  tensions between Israel and its neighbors) could
  affect oil prices if the fear premium rises
  following threats to supply.
• The Middle East is an arc of instability that
  goes from the Maghreb all the way to Af-Pak.
• The Middle East and oil prices have been a major
  source of geo-political tension on global
  markets.
• Previous US and global recessions have been
  associated with stagflationary oil price shocks
• But so far markets have ignored the geopolitical
  risks in the Middle East? Why? Will this change
  or not?
• What is the outlook for oil prices? Will they
  remain low?

76
East as in East Asia

• China experienced rapid economic growth and
  overheating in the 2003-2008 period
• The GFC led to a massive growth slowdown in China
  in the fall of 2008. But the aggressive policy
  reaction of China led to a robust growth
  recovery. But China risks now a hard/rough
  landing unless it changes its growth model fast
  enough
• Indias dynamism in IT contributed to high growth
  in last decade. But India now faces severe fiscal
  problems and need for major structural reforms.
  Growth slowed down sharply after 2012. Will the
  new Modi government accelerate reforms to boost
  growth?
• East Asia growth strongly depends on China and
  the US. A number of Asian EM may be at risk given
  China
• Japans recession in 2008-09 was very severe and
  the recovery anemic. Will now Abenomics work or
  not?
• Asia geopolitical tensions Will China rise
  peacefully?

77
Earnings/Equity markets (2004-2009)

• Equity markets in the US and globally did well in
  the 2006-2007 given high global economic growth
• High earnings growth, much improved corporate
  balance sheets, easy monetary conditions
  supported equities
• Profits sharply increased as a share of GDP
• But during the recent global financial crisis US
  and global equities sharply fell (by over 50
  btw the fall of 2007 and March 2009) with a bear
  market that experienced a number of bear market
  rallies.
• Since March 2009 a massive rally in U.S. and
  global equity markets (over 150). Is it
  excessive and at risk of a significant correction
  or bound to rise further?
• Some disconnect between slow recovery of the real
  economies and rapid rise in equity prices.

78
Earnings/Equity markets (2010-2017)

• Background on US equity markets in the 2000-2017
  period
• The U.S. and global economic slowdown in 2001 led
  to a sharp slowdown of earnings and
  underperformance of equity markets (on top of the
  dotcom bust and Nasdaq collapse in 2000).
• Equity markets also underperformed in 2002 as the
  stock market rally after the 9/11 drop was
  excessive and based on overoptimistic
  expectations of growth.
• Stock markets slumped again in the first quarter
  of 2003 as the concerns about a war with Iraq led
  to renewed risk aversion.
• But they then recovered sharply after the war in
  2003 as markets started to expect a sustained
  economic recovery and a sharp pick-up in profits
  and earnings.
• But stock indexes remained mostly flat on average
  in 2004 and even in 2005 and 2006 (with only a
  modest uptrend since 2004) even if corporate
  balance sheets have improved sharply (with debt
  de-leveraging) and earnings growth has been
  sustained in 2004-2006.
• Equity markets in the US and abroad rallied
  sharply in 2006-2007
• Bear market in equities starting with the
  financial turmoil in the fall of 2007
• Bottom of the bear market in March 2009 and then
  rapid recovery through 2014 with some episodes of
  risk off followed again by risk on.
• In 2013 sharp rally of US equities that continued
  at a slower pace in 2014.
• Is the US stock market overvalued? Will a
  correction occur or will it continue to trend up
  and by how much in 2017 and beyond?
• Trumps election led to another leg up in US
  equities as his policies are expected to be
  business friendly but valuations looks stretched

79
Linkages between the U.S. and the rest of the
world occur via various channels

• Trade
• Capital flows and FDI (Europe, Japan, Emerging
  markets)
• Value of the US dollar
• US monetary and fiscal policy
• Global stock markets and financial links
• Developments in oil and commodity markets
• Political shocks and risks
• Global investors and corporate confidence

80
Fed policy 2000-2017

• The Fed reduced the Fed Funds rates 11 times in
  2001, by 475pbs to a rate of 1.75 as the economy
  entered a recession.
• Faltering in the US recovery in the fall of 2002
  led the Fed to cut the Fed Funds again, down to
  1.25 in November 2002 and down to 1 in June
  2003 as a jobless recovery emerged during the war
  with Iraq.
• In 2004, as growth of output and jobs picked up
  and inflation started to increase, the Fed
  started to increase the Fed Funds rate in 17
  consecutive steps bringing it to 5.25 by June
  2006 and then pausing in August 2006.
• The risk of a US hard landing and the market
  turmoil in the summer of 2007 led the Fed to cut
  rates starting in the fall of 2007 from 5.25 to
  effective 0 in 2008
• QE in 2008-13 during/after the financial crisis
  unconventional monetary policy. QE tapering
  started in Degc 2013. ZIRP exit in 2016 and 3
  hikes since then.

81
US fiscal policy since 2008

• Fiscal stimulus in 2008 as the economy entered a
  recession
• As second 900 billion fiscal stimulus legislated
  in early 2009
• Deficit for 2009 rose to be 1.4 trillion but is
  now much lower (450 bn) or 3 of GDP in 2015
• Fiscal path deficit and debt - is clearly
  unsustainable as over the next decade deficits
  will rise again unless entitlement spending is
  reformed (Social Security and Medicare)
• Difficult issue of when to exit from the fiscal
  stimulus. The U.S. postponed till 2012 but
  serious fiscal drag in 2012-13 given spending
  cuts/sequester and rise in taxes
• 2013 showdown on government shutdown and debt
  ceiling
• Will fiscal fights in Congress resume in late
  2017 on debt ceileing and government shutdown?
• How large will the Trump fiscal stimulus be (tax
  cuts, infrastructure and defense spending) and
  how much will it increase the deficit?

82
Global current account imbalances

• Are the global current account imbalances (still
  large deficit in the US and fragile EM, large
  surpluses in Europe, China and some emerging
  market economies) sustainable over time?  
• Is the US current account deficit and external
  debt accumulation sustainable? It is shrinking
  but maybe too slowly?
• Will the adjustment of global imbalances be
  orderly or disorderly?
• Is the global current account adjustment to
  asymmetric as deficit countries need to retrench
  while surplus countries arent reducing their
  surpluses? Is this deflationary for the world?
• How will the major currencies (, Yen and Euro)
  perform? Will the dollar weaken or strengthen
  over time?
• Is the recent 2104 dollar strength sustainable
  and how will it affect the US external balance,
  growth and inflation?
• Is the risk of a hard landing of the US dollar -
  especially if the foreign creditors of the US get
  tired of financing the US twin fiscal and current
  account deficits reduced as the twin deficits
  are now smaller?
• Will EM with external deficit experience a sudden
  stop/crisis?

83
Global deflation or inflation? and commodity
prices

• Until 2007 and early 2008 there was concern about
  global inflation as global growth was robust,
  emerging market economies were overheating and
  experiencing double digit inflation (30 plus
  countries) and as commodity prices were rising
• But once the US recession became global in the
  second half of 2008 serious deflationary
  pressures emerged in the global economy because
  of slack in goods markets, slack in labor markets
  and sharply falling commodity prices
• By spring of 2009 economies experiencing actual
  deflations included US, Eurozone, Japan, China
  and a number of other advanced economies and
  emerging markets
• Will inflation return as the global economic
  recovery may accelerate in 2017 and beyond? Or
  are disinflationary forces stronger?
• Will inflation surprise to the upside in the US
  and cause the Fed to be behind the curve
  regarding exit from zero rates?
• Should we worry more about inflation or about
  deflation and over which time horizon should we
  worry more about one or the other?
• Is the commodity super-cycle really over and why?
• Why is inflation still so low in US and other
  advanced economies?

84
Some of the cutting edge issues (and jargon
terminology used) in international macro policy
debates

• Why did the subprime crisis lead to a wider
  credit crunch?
• Was the crisis due to a liquidity crunch or a
  credit crunch/solvency crisis?
• What is the risk of a another systemic crisis and
  what factors trigger one?
• What causes asset bubbles? What causes housing
  bubbles and bust?
• How should monetary policy react to asset bubbles
  and asset bubbles bursting? Should central banks
  address bubbles with a rise in interest rates or
  via macro-prudential supervision and regulation?
• Should we worry about deflation or inflation?
• How will central bank exit unconventional
  monetary policies (ZIRP, QE, CE, FG, NDR)?
• What is the risk of sovereign debt crises in
  developed markets?
• Why is income and wealth inequality rising and
  what is the impact of it?
• Are advanced economies at risk of secular
  stagnation and why?

85
Some of the cutting edge issues in international
macro policy debates

• Should we worry about stagflation or
  stag-deflation?
• Are global external imbalances sustainable or
  not, and for how long?
• Are twin fiscal and current account deficits
  sustainable in DM and EM?
• Should we worry about asset protectionism and
  restrictions to FDI?
• Should we worry about capital controls on inflows
  and outflows?
• Should we worry about resource protectionism?
• What is the future of offshore outsourcing?
• Is the trade liberalization Doha round as dead as
  Dodo?
• Is free trade compatible with flexible exchange
  rates or does greater trade integration require
  managed or pegged exchange rates?
• Is globalization at risk of reversal?
• Should we be optimist or pessimist about the pace
  of future technological innovation?
• Will robots/automation replace most jobs?
• What explains the rise in inequality and what can
  we do about it?

86
Some of the cutting edge issues in international
macro policy debates

• Are highly-leveraged institutions and hedge funds
  a source of systemic risk?
• What is the risk of new asset and credit bubbles?
• Is housing frothy and bubbly in some economies?
• Will macro-pru be effective in ensuring financial
  stability or not?
• Is offshore outsourcing a threat or a benefit for
  the global economy?
• Will the BRICs dominate the world economy in the
  next decades?
• Is the balance sheet approach the appropriate
  framework for thinking about financial crises in
  emerging economies?
• Are crises due to fundamentals or self-fulfilling
  liquidity runs?
• What explains sudden stops and reversals of
  capital inflows?
• What explains the joint eruption of currency,
  sovereign debt, systemic banking and systemic
  corporate crises?      

87
Some of the cutting edge issues in international
macro policy debates

• What is the appropriate form of
  PSI/bail-in/burden-sharing in crisis resolution?
• Do we need an international lender of last resort
  (ILOR)?
• What explains international contagion?
• How to deal with liability dollarization and
  original sin?
• Do we need an international bankruptcy regime for
  sovereigns?
• What is the most desirable sovereign debt
  restructuring mechanism?
• Do emerging markets suffer of fear of floating
  and if so why?
• Is unilateral dollarization the way of the
  future?
• Are monetary unions feasible without broader
  banking, fiscal, economic and political unions?
• Is sterilization of excessive capital inflows
  feasible and desirable?
• What is the desirable reform of the international
  financial architecture?
• Will the US dollar remain the main global reserve
  currency?
• Will the Chinese RMB emerge as a major global
  currency?

88
Sources of International Macroeconomic
Interdependence among Economies

• Macroeconomics is international given the
  increasing economic interdependence among
  countries and the increased globalization of
  trade and finance.
• Trade links 
• Income effects on imports and exports of goods
  and services
• Direct and indirect trade links
• Exchange rate effects on trade

89
Financial channels of interdependence

•  Assets/Liabilities traded internationally
• Stocks
• Bonds
• Derivative instruments (in the GFC)
•  International financial markets/intermediaries
• Banks
• Capital markets (stock/bond/money markets)
• Foreign exchange markets
• Commodities markets

90
Interdependence channels via common shocks and
FDI/MNCs

• Common sectoral/external shocks
• Common oil and commodity shocks
• Tech sector technology shock in the mid 1990s and
  bust in 2000-2001
• Housing bubbles in the US and other countries
  and their bust in 2007-09
• Global credit crunch
• Foreign Direct Investment (FDI)/ Multinational
  Corporations (MNCs)