http://www.youtube.com/watch?v=1w-pODAjVyE http://www.econ.queensu.ca/GuestLecturerVideo

1. Has the financial crisis changed
the world? Martin Wolf, Associate
Editor & Chief Economics
Commentator, Financial Times
John Weatherall Public Lecture
October 2 2013
Queen’s University, Kingston, Ontario

2. Panic
2

3. Has the financial crisis changed the world?
• It is too soon to know. But I do hope it has.
• In this lecture, I intend to address the following four
issues:
– Where we are.
– How we got here.
– Where we go.
– What we learn.
3

4. 1. Where we are
• The high-income countries have been stuck in a
“contained depression” for six years.
• What are the symptoms of this malady?
• The answer is the combination of:
– Weak economies;
– aggressive monetary and (to a lesser degree) fiscal policies;
– and low inflation.
• Meanwhile crisis-hit eurozone members have fallen
into deep slumps.
4

5. 1. Where we are – the slump
THE LONG RECESSION
GDP IN THE "GREAT RECESSION"
106.0
104.0
102.0
100.0
98.0
96.0
94.0
92.0
90.0
Q1 2008
Q1 2009
Eurozone
5
Q1 2010
Germany
Q1 2011
France
US
Q1 2012
UK
Italy
Q1 2013

6. 1. Where we are – fiscal deficits
EXPLODING FISCAL DEFICITS
GENERAL GOVERNMENT BORROWING
(per cent of GDP)
4
2
0
-2
-4
-6
-8
-10
-12
-14
-16
United States
United
Kingdom
2006
6
2007
Japan
2008
France
2009
2010
Italy
2011
Canada
2012
2013
Germany

7. 1. Where we are – public debt
LEAD TO SOARING PUBLIC DEBT
NET PUBLIC DEBT (over GDP)
160
140
120
100
80
60
40
20
0
Canada
Germany
France
2007
7
United
States
2010
2013
United
Kingdom
2016
Italy
Japan

8. 1. Where we are – monetary policy
A WORLD OF FREE MONEY
CENTRAL BANK POLICY RATES
7
6
5
4
3
2
1
0
1/1/99
1/1/00
1/1/01
1/1/02
Federal Reserve
8
1/1/03
1/1/04
1/1/05
Bank of Japan
1/1/06
1/1/07
1/1/08
1/1/09
Bank of England
1/1/10
1/1/11
1/1/12
1/1/13
European Central Bank

9. 1. Where we are – monetary policy
AND EXPANDING MONETARY BASE
BALANCE SHEET OF THREE CENTRAL BANKS
500.0
450.0
400.0
350.0
300.0
250.0
200.0
150.0
100.0
50.0
0.0
Federal Reserve
9
ECB
Bank of England

10. 1. Where we are – monetary policy
YET MONETARY GROWTH CEASES
MONEY SUPPLY IN THE GREAT RECESSION
350.0
300.0
250.0
200.0
150.0
100.0
US M2
10
Euro M3
UK M3

11. 1. Where we are – long-term interest rates
BOND YIELDS FALL TO VERY LOW LEVELS
YIELDS ON 10-YEAR GOVERNMENT BONDS
10
9
8
7
6
5
4
3
2
1
0
Germany
11
UK
US
Japan
Canada

12. 1. Where we are – eurozone depressions
SLUMPS IN CRISIS-HIT EUROZONE COUNTRIES
GDP SINCE THE CRISIS
105.0
100.0
95.0
90.0
85.0
80.0
75.0
70.0
Jan-08
Jul-08
Jan-09
Italy
12
Jul-09
Spain
Jan-10
Jul-10
Greece
Jan-11
Jul-11
Ireland
Jan-12
Portugal
Jul-12
Jan-13

13. 1. Where we are – eurozone depressions
UNEMPLOYMENT IN CRISIS-HIT COUNTRIES
STANDARDISED UNEMPLOYMENT RATES
30
25
20
15
10
5
0
1/1/07
1/1/08
Germany
13
1/1/09
Italy
1/1/10
Spain
1/1/11
Greece
1/1/12
Portugal
1/1/13
Ireland

14. 2. How we got here
• The crisis is the result of a complex interaction
between two forces:
– A global saving glut; and
– A fragile financial system
• When the “Minsky moment” came in 2007-08, the
results were:
– A huge financial crisis;
– State-backing of the core financial system; and
– The hyper-aggressive monetary and fiscal policies.
14

15. 2. How we got here – asset bubbles
BEGINNING AND END OF HOUSING BUBBLES
REAL HOUSE PRICES AND REAL INDEX-LINKED
YIELDS
300.00
4
250.00
3
200.00
2
150.00
1
100.00
0
50.00
-1
0.00
Real House Prices
5
-2
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
US real (S&P Case Shiller National)
15
UK real Nationwide
Spain real
UK 10-year IL gilts
Index-linked Yield
350.00

16. 2. How we got here – global imbalances
WHERE EXCESS SAVINGS CAME FROM
GLOBAL IMBALANCES (as per cent of world GDP)
4
3
2
1
0
-1
-2
-3
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
US
Oil exporters
Germany and Japan
Peripheral Europe
China and Emerging Asia
Rest of world
Discrepancy
16
2016

17. 17
China
Rest of Asia
Rest of developing countries
Industrial countries
Jan-13
Jul-12
Jan-12
Jul-11
Jan-11
Jul-10
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
Jan-05
Jul-04
Jan-04
Jul-03
Jan-03
Jul-02
Jan-02
Jul-01
Jan-01
Jul-00
Jan-00
Jul-99
Jan-99
Jul-98
Jan-98
Jul-97
Jan-97
2. How we got here – global reserves
THE ROLE OF GOVERNMENTS
FOREIGN CURRENCY RESERVES ($bn)
$12,000
$10,000
$8,000
$6,000
$4,000
$2,000
$0

18. 2. How we got here – asset bubbles
THE RISE OF THE LEVERAGED ECONOMY
US CUMULATIVE PRIVATE SECTOR DEBT OVER GDP
350.0%
300.0%
250.0%
200.0%
150.0%
100.0%
50.0%
0.0%
Households
18
Non-financial Business
Financial Sectors

19. 2. How we got here – financial leverage
LEVERAGE IN PRE-CRISIS UK BANKING
19

20. 2. How we got here – eurozone
• The core of the eurozone financial crisis is not fiscal
• The fiscal crisis is more a symptom of the financial
crisis than a cause of that crisis
• The crisis is largely the result of divergences
accumulated in the years of excess: what made
everything seem so good was in fact creating an
acute long-term crisis
• External imbalances played a far bigger role than
fiscal imbalances: it mattered less whether the
private or public sectors were being financed than
how big the external finance was
20

21. 2. How we got here – eurozone imbalances
THE ROAD TO THE EUROZONE CRISES
EUROZONE IMBALANCES ON CURRENT ACCOUNT
(as per cent of Eurozone GDP)
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
-4.0%
1998
2000
2002
2004
2006
2008
2010
2012
Axis Title
Germany
France
Vulnerable countries
21
Other persistent surplus
Others
Eurozone
2014
2016

22. 2. How we got here – eurozone imbalances
THE ROAD TO THE EUROZONE CRISES
AVERAGE CURRENT ACCOUNT BALANCES 2000-08
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0
-10.0
-12.0
22
5.6
5.4
3.5
2.5
2.0
0.2
-0.9
-2.3
-6.2
-9.2
-9.7

23. 2. How we got here – eurozone debt
NOT THE ROAD TO THE EUROZONE CRISES
GOVERNMENT NET DEBT OVER GDP (per cent)
120.0
100.0
80.0
60.0
40.0
20.0
0.0
-20.0
-40.0
-60.0
-80.0
-100.0
23

24. 2. How we got here – eurozone debt
CRISIS-HIT COUNTRIES SUFFER
NET GOVERNMENT DEBT OVER GDP (per cent)
200.0
180.0
160.0
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
Greece
Italy
Portugal
2007
24
2010
2013
Spain
Ireland

25. 2. How we got here – eurozone yields
CRISIS-HIT COUNTRIES SUFFER AND RECOVER
SPREADS OVER GERMAN BUNDS
16
14
12
10
8
6
4
2
0
-2
12/30/05
12/30/06
12/30/07
12/30/08
12/30/09
12/30/10
Portugal
Italy
Spain
3-year Long-term refinancing operation
25
Ireland
"Whatever it takes"
12/30/11
12/30/12

26. 3. Where we go
• Does this crisis mark a permanent slowdown in the
growth dynamic of the high-income countries
• How does a growth slowdown affect debt
management? Remember debts can be managed
by:
– Fast growth;
– Inflation;
– Low interest rates; and
– Outright default
• If growth is slow, it is the other three that must
happen
26

27. 3. Where we go
THE LONG SLUMP
US GDP AGAINST TREND TO 2007 IV ($bn)
$20,000
10.0%
$18,000
5.0%
$16,000
$14,000
0.0%
$12,000
$10,000
-5.0%
$8,000
-10.0%
$6,000
$4,000
-15.0%
$2,000
$0
Q1
1980
-20.0%
Q1
1983
Q1
1986
Q1
1989
Q1
1992
US GDP annualised (bn)
27
Q1
1995
Q1
1998
Q1
2001
Q1
2004
Trend to 2007 IV
Q1
2007
Q1
2010
Deviation
Q1
2013

28. 3. Where we go
THE LONG SLUMP
EUROZONE GDP AGAINST TREND TO Q4 2007 (euro bn)
€ 3,000
4.0%
2.0%
€ 2,500
0.0%
€ 2,000
-2.0%
-4.0%
€ 1,500
-6.0%
€ 1,000
-8.0%
-10.0%
€ 500
-12.0%
€0
Q1
1995
-14.0%
Q1
1997
Q1
1999
Q1
2001
Q1
2003
Q1
2005
Eurozone (at 2000 Constant Prices)
28
Q1
2007
Q1
2009
Trend
Q1
2011
Deviation
Q1
2013

29. 3. Where we go
THE LONG SLUMP
UK GDP AGAINST TREND TO 2007 Q IV (£bn)
£500
10.0%
£450
5.0%
£400
£350
0.0%
£300
£250
-5.0%
£200
-10.0%
£150
£100
-15.0%
£50
£0
Q1
1980
-20.0%
Q1
1983
Q1
1986
Q1
1989
Q1
1992
Q1
1995
UK GDP quarterly (bn)
29
Q1
1998
Q1
2001
Q1
2004
Trend to 2007 IV
Q1
2007
Q1
2010
Deviation
Q1
2013

30. 3. Where we go - potential
•
Economies have responded in two ways to the
crisis:
–
Productivity collapse and strong employment (e.g.
Germany and the UK)
–
Rising productivity and weaker employment (e.g. US and
Spain)
•
Which of these indicates the best supply potential?
•
Answer: we do not know. Will productivity rebound
or will employment rebound?
30

31. 3. Where we go - employment
DIVERGENT EMPLOYMENT PERFORMANCE
EMPLOYMENT OVER POPULATION RATIOS (AGED 15-65)
75.0
70.0
65.0
60.0
55.0
50.0
Germany
United Kingdom
United States
2007
31
France
2012
Italy
Spain

32. 3. Where we go - productivity
PRODUCTIVITY GROWTH COLLAPSE
CHANGES IN OUTPUT PER WORKER 2007-12 (PPP $s)
12.0%
11.0%
10.0%
8.0%
5.6%
6.0%
4.0%
1.5%
2.0%
0.9%
0.2%
0.0%
-0.7%
-2.0%
-3.0%
-4.0%
-4.2%
-6.0%
Spain
32
United
States
Canada
Japan
France
Germany
United
Kingdom
Italy

33. 3. Where we go - recovery
• Whatever the potential for supply may be, where is
the demand going to come from?
• With fiscal policy contractionary, it must come from
private spending.
• In practice, rising consumption driven by credit
growth is a necessary condition for a sustained
recovery.
• So monetary policy is likely to remain ultra-easy.
• But such an expansion might prove unsustainable.
33

34. 4. What we learn
• First, our economic ideas have been discredited:
– Back to Wicksell, Hayek and Keynes
– End of market utopianism.
34

35. 4. What we learn
• Second, the financial system is crisis prone:
– We have allowed private institutions to serve a fundamental
public function – the creation of money.
– The result, in a fiat money system, in which bank reserves
can be created without limit, is an explosive system.
– The financial system is always part of the state. It is not fully
private.
– We need to make the financial system much more robust.
– The three most important reforms are higher capital ratios
and workable macro-prudential policies.
35

36. 4. What we learn
• Third, we may be moving into secular stagnation in
the high-income countries:
– Slowing trend productivity growth;
– Deteriorating demographics;
– Debt overhangs; and
– Financial repression.
36

37. 4. What we learn
• Fourth, large current account imbalances (i.e.
external imbalances) always suggest a crisis is on
the way:
– The concern over imbalances felt by Keynes at Bretton
Woods remains valid.
– But there is no mechanism to ensure global balance.
– Indeed, the role of the dollar seems to make balance almost
impossible to achieve.
37

38. 4. What we learn
• Fifth, management of the world economy has
become more difficult as the economic and political
weight of the West has declined.
– We are in another period of difficult transition between
hegemonic powers, as in the 1920s and 1930s.
– The relationship between the US and China will be far more
difficult than between the US and the UK.
– China cannot be the hegemon of a global market economy.
38

39. 4. What we learn
• Sixth, the eurozone is a bad marriage, but divorce is
very costly. Can it be made a good marriage?
• For that it needs:
– Debt restructuring – debt overhangs are now large.
– Financing – largely supplied by the European Central Bank
– Adjustment – symmetrical adjustment of income and
spending
– Fundamental reform – a banking union and a minimum fiscal
union.
39

40. 5. Conclusion
• Here are my four main conclusions:
– We are in a contained depression. It will not end until we
have sustained growth at “normal” interest rates and without
unsustainable debt build-ups.
– We got here because of the interaction of macroeconomic
imbalances with an inherently unstable financial system.
– It is not clear what sort of “normal” the high-income countries
can get back to. That will, in turn, determine how the
post-crisis debt overhang is handled and where we end up.
– We need to learn some big lessons about how to
understand and handle our economies and financial
systems, including not least in the eurozone.
40