- 2018-11-27
How to avoid the next financial crisis?
The 2008-2009 financial crisis and the resulting recession is a historical watershed. The world before the crisis was a globalized world with faith in the market and confidence in democracy. Today, everything is reversed.
The economic impact is certainly not the end of the story. But the economic impact is the beginning. The latest World Economic Outlook issued by the International Monetary Fund (IMF) provides a valuable empirical analysis of these effects. It raises two important questions: The impact is long-lasting, and the scope of the impact far exceeds that of countries suffering from banking crises.
To measure the economic impact of the crisis, the obvious way is to compare the economic performance after the crisis with the results that will occur if the pre-crisis trend continues. However, to some extent, the pre-crisis trend is not sustainable. Therefore, the IMF's analysis adjusted the trend growth rate before the crisis, excluding the impact of the credit boom.
The IMF pointed out that "91 economies accounting for two-thirds of the world's gross domestic product (GDP)" in terms of purchasing power parity experienced a decline in output in 2009. This was the most serious blow to output after World War II. In addition, the greater the short-term loss of output, the greater the long-term loss. In countries where output has experienced a sharp immediate decline, income inequality has also increased to a greater degree relative to the pre-crisis average.
Which countries suffered the most serious output losses, and how much did they lose? To answer this question, the World Economic Outlook divides its sample of 180 countries into countries that have suffered a banking crisis and countries that have not suffered a banking crisis.
The first group includes 24 countries, 18 of which are high-income economies. The report found that 85% of the output is still below the trend level. For those countries suffering from banking crises, the average output loss from 2015 to 2017 (the most frequently occurring) output loss was close to 10%. But many suffered losses of 20% to 40%. However, in countries that have not suffered a banking crisis, 60% of output is still below the pre-crisis trend. The mode decline is about the same as that of countries suffering from crisis, but the distribution is not so skewed downward.
The prevalence of output losses may not be so surprising: the crisis originated at the core of the global economy and caused a sharp decline in global demand. The result was a severe recession, which cast a long shadow over the future.
Similarly, although developed economies have been hit particularly hard, emerging economies have not performed much better. This is a Western financial crisis, but it is also a global economic crisis. China's economic stimulus plan of about 10% of GDP has greatly cushioned the impact of the crisis.
The most direct explanation for the huge output loss is the cliff-like decline of investment: By 2017, investment was on average a quarter below the pre-crisis trend. This weak investment will certainly help explain the low rate of innovation, which is particularly evident in countries directly hit by the crisis. New technologies are usually embodied in new equipment: such as robots.
From 2011 to 2013, compared with those countries that did not suffer from the banking crisis, the output losses of those countries that suffered a banking crisis were on average 4 percentage points higher. Countries that had huge macroeconomic imbalances (especially unsustainable current account deficits) before the crisis also experienced relatively large output losses. The same is true for countries with relatively inflexible labor markets. Similarly, those countries where more exports go to markets affected by the crisis will suffer more serious losses. Those countries that are more closely connected with the global financial system also suffer greater output losses. Facts have proved that the lack of space for fiscal policy operations is costly, as is the lack of exchange rate flexibility. The last point is certainly one reason for the very poor performance of the Eurozone, but it is not the only reason.
The monetary measures taken by high-income countries after the crisis have been controversial in many emerging markets. Many people in high-income countries have always argued that the original large-scale monetary easing policy was a mistake. However, the evidence showing that output losses are cumulative makes the arguments against strong long-term policy support untenable. However, a stronger fiscal policy response would have reduced the need to implement non-traditional monetary policies for such a long time.
Here are 3 tasks and a lesson.
The first task is to normalize monetary policy in this highly indebted world. The U.S. policy rate hike has exposed the fragility of many emerging economies. It seems likely that there will be more turbulence.
The second task is how to deal with another large-scale recession when the policy space is severely narrowed.
The final task is to deal with the political impact of the crisis. The decline in the credibility and relative power of the West, as well as the rise of provocative forces, are practical, powerful, and dangerous.
The lesson is that it is no surprise that large-scale financial crises are extremely destructive. Once it happened, it was too late. The analysis of regulation in the October Global Financial Stability Report shows that we must ignore the complaints of banking professionals about regulation: most importantly, we must maintain high capital requirements.
If fiscal and financial measures were continued, the recovery could have been stronger, especially in the Eurozone. But the cost of the crisis will remain high. We must take "No Next Time" as the motto.