Introduction to the Course and Main Issues in the Global Economy - PowerPoint PPT Presentation

View by Category
About This Presentation

Introduction to the Course and Main Issues in the Global Economy


How hard will be the US hard landing (recession) ... The housing recession is worsening rather than bottoming out. Spillovers of the housing recession to other ... – PowerPoint PPT presentation

Number of Views:128
Avg rating:3.0/5.0


Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Introduction to the Course and Main Issues in the Global Economy

Introduction to the Course and Main Issues in
the Global Economy  
  • by   Nouriel Roubini
  • Stern School of Business
  • New York University  
  • September 2017

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

International Macroeconomic Policy
  • Macroeconomic developments depend on macro
  • 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)

International Macroeconomic Policy
  • Macroeconomic developments depend on macro
  • 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

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)

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
  • EM mini-crisis in 2013-15 and Chinas 2015-16

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

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)

Liquidity versus Solvency Crises
  • Many combinations of liquidity/illiquidity and
  • 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
  • Insolvency is resolved via
  • Orderly debt restructuring before default
  • Disorderly debt restructuring (default and debt

Course Structure
  • Syllabus http//
  • Textbooks
  • Reading List http//
  • Assignments http//
  • Requirements (assignments, mid-term exam, final
  • Other online and offline tools for the course

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
  • The world economy is characterized today by many
    known unknowns, for example which who will be
    the next Fed Chairman.

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

Known Unknown Economy, Tax policy and the Fed
  • Will economic growth finally accelerate above
  • Will wage and price inflation remain contained or
  • 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?

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?

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?

Macro and market implications of these known
  • 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.

Current Known Unknowns in the Global Economy
  • U.S. economic, political, geopolitical, monetary,
    fiscal and trade uncertainties given the Trump
  • Prospects for growth in developed markets (DM
    US, Europe, Japan, etc.) and emerging markets
  • Will DM return to strong growth or will the
    recovery remain anemic and sub-par? Expansion or
  • Is the recent slowdown in EM cyclical or
  • 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?

Current Known Unknowns Brexit and
  • Will the UK truly exit the EU or eventually
  • 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)?

Current Known Unknowns in the Global Economy
  • 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
  • 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?

Current Known Unknowns in the Global Economy
  • Will Abenomics work in Japan?
  • Stronger growth and inflation increase or
  • 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?

Current Known Unknowns in the Global Economy
  • 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?

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
  • 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?

Current Known Unknowns in the World
Geopolitical Risks
  • US and the Trump political/geopolitical
  • Is a military conflict with North Korea likely?
  • Will the Russia-Ukraine conflict escalate or not?
  • Syria-Iraq-ISIS further destabilization or
  • 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

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?

Current known unknowns Unconventional monetary
  • 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
  • Will the baton be passed from monetary to fiscal
  • Which policies for Fed, ECB, BoJ, BoE, PBoC, SNB?

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
  • 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
  • Since mid 2016 we have global acceleration/expansi
    on led by accommodative policies and better

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)

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

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

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

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)

The global economy after the global financial
crisis (GFC)
  • The economic recovery after the GFC was
  • 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
  • Higher potential growth (5 in EM vs 1-2 in DM)
  • More room for policy response

Why U-shaped Recovery in DM?
  • The 2008-09 crisis was not a plain vanilla
  • 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
  • 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)

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
  • 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)

Side effects of the massive policy response
during the GFC
  • The massive monetary/fiscal/bailout response
    during the GFC was necessary to avoid another
  • 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?

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
  • Bernanke learned the lessons of the Great

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?

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)?

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

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

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

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

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

Why slowdown of Growth in EM and Financial
  • 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

Why slowdown of Growth in EM and Financial
  • 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
  • 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

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

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
  • Lower private/public/external deficits and debts
    less solvency risk
  • Better regulated banks and financial systems

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
  • 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.

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

Medium term optimism for EM in spite of short run
  • 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
  • Ability to absorb existing and new technologies
    developed in DM
  • Technological innovation in some EM (Korea,
    China, India, etc)

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

US growth is improving in 2017 after a rocky
  • U.S. economy is in a tentative improvement growth
  • 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
  • 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?

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

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
  • Risk of credit/asset bubbles as Fed exit is slow.
    Will macro-pru work?

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

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
  • 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

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)

Some Positives in the EZ Today
  • Return to growth even if recovery is
  • 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.

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

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
  • ECB only game in town as fiscal policy is
  • Brexit contagion to EU integration?

Draghinomics looks like Abenomics
  • Draghi Slow growth depends also on aggregate
    demand not only on supply constraints (slow
  • 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

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
  • The rise of the consumption tax in 2014 led to Q2
    negative growth now the 2017 hike has been
  • Is Japans public debt sustainable in the long
  • For how long will the BoJ continue its QE and
    NIRP policies?

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
  • Will the structural reforms be implemented fast
    enough after the Party Congress to rebalance
  • 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

Major Es in the global economy The 2010-2016
  • 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

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

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

Causes of the housing/credit bubble and
  • Easy monetary policy (the Fed tightened too
    little too late)
  • Lax supervision and regulation of the financial
  • 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

  • US/global recessions have been associated with
    oil price spikes (1973-74, 1979-80, 1990-91,
  • 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

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
  • 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

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

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

  • 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
  • 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
  • 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
  • Will the recent EZ growth pick-up since 2016

Emerging market economies (2000-2013)
  • Emerging market (EM) economies experienced many
    economic and financial crises in the 1994-2002
  • 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.

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
  • 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
  • But in 2013-15 many EM faced slowdown.
  • Recovery of growth and markets in EM since 2016.

East as in Middle East
  • Oil prices are low today given the shale
  • 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
  • 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?

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
  • 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
  • East Asia growth strongly depends on China and
    the US. A number of Asian EM may be at risk given
  • Japans recession in 2008-09 was very severe and
    the recovery anemic. Will now Abenomics work or
  • Asia geopolitical tensions Will China rise

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
  • 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.

Earnings/Equity markets (2010-2017)
  • Background on US equity markets in the 2000-2017
  • 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

Linkages between the U.S. and the rest of the
world occur via various channels
  • Trade
  • Capital flows and FDI (Europe, Japan, Emerging
  • 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

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.

US fiscal policy since 2008
  • Fiscal stimulus in 2008 as the economy entered a
  • 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
  • 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?

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

Global deflation or inflation? and commodity
  • 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?

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

Some of the cutting edge issues in international
macro policy debates
  • Should we worry about stagflation or
  • 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
  • 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?

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?      

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
  • What explains international contagion?
  • How to deal with liability dollarization and
    original sin?
  • Do we need an international bankruptcy regime for
  • 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
  • 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
  • Will the Chinese RMB emerge as a major global

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

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

Interdependence channels via common shocks and
  • 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)