MBA35 Managerial Excellence The economic crisis (2 lectures) The firm and its environment (part 2) Francesco Giavazzi

Timeline of the crisis 1.Fall in house prices 2.Banks’ losses and increases in Var 3.How did banks reduce leverage i.Contraction of lending (“credit crunch”) ii.Sales of securities (firesale effect on securities’ prices) iii.Market recapitalization (up to 06/08) 4.Lehman Brothers’ default (09/15/08) i.The interbank market freezes (09/08) ii.Public guarantees iii.Firesales, stock market crash 5.Hoseholds’ wealth falls (houses, stock market) consumption falls (10/08-03/09) 5.Monetary and Fiscal Policy responses

Banks’ losses and recapitalization up to Lehman’s failure

Autumn 2008: the beginning of a serious recession Trasmission of the crisis – To the real economy via the fall in private wealth – To the rest of the world trade banks’ losses in other countries (Especially in Germany and UK)

U.S. GDP Growth Contributions 1/ (in percent; qoq saar) 1/ For the seven quarters following the trough. Real GDP

U.S. GDP Growth Contributions 1/ (in percent; qoq saar) 1/ For the seven quarters following the trough. Real GDP

Real GDP Growth (in percent; qoq; saar) International trasmission 09Q2 Advanced World Emerging

International trasmission

Industrial Production (percent change; 3mma; annualized) Jul. 09 Advanced Emerging Merchandise Exports (percent change; 3mma; annualized) Emerging Advanced Jul. 09 World

Central banks and the Liquidity Trap Policy Rates (in percent) Central Banks Total Assets (index, 1/5/2007=100) Euro area U.K. Japan Canada U.S. U.K. Canada Japan Euro area U.S. LehmanBrothers 4/174/21

The “liquidity trap”

Quantitative Easing: how does it work? ρ = i + x x = x (K B, K F ) I = I (Y, ρ)

QE has worked spread between corporate and Government bonds

Fiscal Policy

Monetary and Fiscal Policies Have Worked daily volatility of the S&P 100 Credit Crunch Source: Nicholas Bloom, Stanford University

The interbank market is back in business 9/14 Three-month Libor – OIS Spreads (basis points) 9/15 Source: IMF

Stock markets (09/01/08 = 100) Source: IMF

Securitization Remains Impaired Securitization Issuance (billions of U.S. dollars) United States Data annualized for Europe

The legacy of the Crisis Debt for sure Inflation maybe

Debt: the Legacy of the Crisis Source: IMF

But the crisis is not the major concern PDV of the fiscal cost of the crisis (yellow) and of the fiscal costs of aging (red) Source: Barrell et al., “How to Pay for the Crisis”, mimeo, 2009

Central banks and the Liquidity Trap Policy Rates (in percent) Central Banks Total Assets (index, 1/5/2007=100) Euro area U.K. Japan Canada U.S. U.K. Canada Japan Euro area U.S. LehmanBrothers 4/174/21

The balance sheet of the Fed

Mortagages430 Comm. paper140 AB comm. Paper 24 Bear Stearns+AIG105 Fannie and Freddie 82 Term facilities: – AB securities loans 15 – auction facility372 T. Bills130 Discount window 40 FX swaps176 Assets acquired by the Fed: 12/07 – 09/09: U.S. $ bn

What about world imbalances Current Account Balances (percent of world GDP)

Where are we now?

Today and the 1930s World Industrial Output Source: Eichengreen, B. e K. O’Rourke, A Tale of Two Depressions, Voxeu.org, Sep 09

GDP Forecasts (Autumn 2009) (quarterly growth at annual rates) Advanced World Emerging Source: IMF

Unemployment, August 2009 Emerging Advanced Fonte: IMF

– Who will replace the US consumer ? – Who will win, where should we invest ? The world after the crisis

U.S. households savings as a share of disposable income

Source: Goldman Sachs Int.

Remember house prices: what cannot continue eventually ends !

What happens if the saving rate of US households goes back to 4% Fall in consumption: 3 pp of US GDP (GDP China) / (GDP US) = 1/3 Additional demand needed to compensate for the fall in US consumption – 10 points of Chinese GDP – Chinese savings: from 50 to 40% of GDP – Eventually (and Brazil and India will alos help) but not immediately

China: composition of demand (% of GDP) Fonte: IMF