Norwegian Business School Oslo, Norway 12 February, 2013

Transcription

1 Norwegian Business School Oslo, Norway 12 February, 2013

2 A credit induced boom and bust of a typical sort Made worse by the weakness of the financial sector and tighter ( procyclical ) financial regulation And worse still by the medium term (unintended) consequences of macroeconomic policies followed in earlier cycles And the fact that all parts of the global economy have now been affected 2/12/2013 2

3 Fiscal expansion supports demand BUT sharply raises sovereign debt levels Support for the financial sector avoids collapse BUT aggravates too big to fail problem Support for the industrial sector (STW) saves jobs BUT impedes needed adjustment Ultra easy monetary policy (UEMP) might support demand BUT certainly has unintended consequences 2/12/2013 3

4 Unprecedented monetary developments: ZLB, credit and quantitative easing, forward rate guidance and Operation Twist Recent developments (Fed, ECB, especially BoJ) imply much more of the same Premised on the belief that lower rates, lower exchanges rates and higher asset prices will increase demand for domestic production YET this is a huge social experiment with different central banks behaving quite differently 2/12/2013 4

5 Will the policy signal get through? Rising credit spreads and tighter credit conditions Deflation and rising real rates Everyone cannot devalue simultaneously Higher asset prices have their own dangers Will consumers and investors react? Could the message reduce confidence in the future Consumers restrained by need to save more, debt overhang, and lower investment income Investment restrained by general uncertainty, short termism and pension shortfalls 2/12/2013 5

6 Wicksell (1898)and the possibility of rising inflation Hayek (1920) and misallocations of real resources Koo (1990)and inadequate saving and debt accumulation BIS (2000) and procyclicality Shin, Tobias (2010) and the emergence of a shadow banking system 2/12/2013 6

7 Creative destruction first requires destruction But easy money encourages evergreening, zombie companies and zombie banks Thus, productivity falls as does potential However, easy money encourages serial bubbles, masking growing imbalances and lower potential The collapse of the Great Moderation and the European Convergence Play was inevitable 2/12/2013 7

8 Easy money in successive downturns works for a time but increases moral hazard for lenders Ultra low rate environment eventually squeezes term premia for banks and threatens the viability of insurance companies and pension schemes Financial firms gamble for resurrection Uncertainty since 2007 has led to risk on/risk off trading (RORO) with unpredictable reversals Fundamentals and diversification no longer useful investment principles 2/12/2013 8

9 Longer term push me factors: currency wars/momentum trading and the failure of UIP/Balassa-Samuelson Shorter term push me factors: RORO and regulatory changes. Both are essentially unpredictable Changing pull me factors in individual countries Broadly, SOE exchange rates have trended up in recent years and bond rates have fallen. 2/12/2013 9

10 Widespread fear of floating, especially for countries with export led growth strategies FX intervention leads to reserve accumulation which lowers bond rates elsewhere Easier monetary policy than otherwise Greater reliance on macro prudential instruments and then capital controls 2/12/

11 Credit growth accelerates Inflation fears rise Buoyant markets: bond spreads fall while equity and property prices rise Real misallocations, especially construction and infrastructure Financial leverage increases and shadow banking emerges as a response to regulation In short, the bubble spreads from AME s to SOE s 2/12/

12 Assume the current uncertainty continues, as does RORO investing The current Risk On phase seems unlikely to last; euro zone complacency/us governance problems/political tensions everywhere SOE s with bubble characteristics could be hit hard Norway could be less exposed to the downside than some other countries 2/12/

13 Assume RORO is replaced by much more stable perceptions of growth prospects Perceptions stabilize on view that monetary policy will ensure strong, sustainable and balanced growth An unlikely outcome given accumulation of imbalances made worse by policy responses US bond rates could rise sharply, while SOE spreads respond once again to fundamentals and diversification Associated dangers? 2/12/

14 Assume RORO is replaced by much more stable perceptions of growth prospects But, perceptions stabilize on view that global growth is likely to be weak for an extended period A more likely outcome After the fall US bond rates rise (from bubble lows) but less sharply, while EME spreads respond once again to fundamentals and diversification. Associated dangers? 2/12/

15 GOOD LUCK You might just need it 2/12/