[PPT] - Major crises: historical comparisons to the Great Depression and the PowerPoint Presentation

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EUROPEAN COMMISSION

DIRECTORATE GENERAL ECONOMIC AND FINANCIAL AFFAIRS

Major crises: historical comparisons to the Great Depression and the classical Gold Standard

Ronald Albers* and Lars Jonung**

*European Commission, DG ECFIN ** Lund University

Presentation for 6th Eurostat Colloquium on “Modern Tools for Business Cycle Analysis: the lessons from global economic crisis”

Disclaimer: The material and views presented here are the sole responsibility of the author and do not in any way represent an official position of the European Commission or of Lund University

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Based on European Economy special report on the crisis (updated version to be published)

http://ec.europa.eu/economy_finance/thematic_articles/article15893_en.htm

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Structure of the presentation

The current crisis from an historical perspective

– Tracking major crises – Extending comparisons with the Great Depression to the classical Gold Standard (1907) – Awareness of the differences: you never step into the same river twice

Policy responses

– What are the key differences with earlier episodes? – What lessons been learnt and are they the right ones? – What options and pitfalls for policy in the period ahead?

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Root causes of the crisis

Macroeconomic roots

Complacency of policy makers (belief

in Great Moderation)

Abundant global liquidity diverted to

real estate (global imbalances)

Rapid credit growth, high leveraging

Microeconomic roots

Originate and distribute model
Complex and opaque financial

products

Conflicts of interest of rating agencies
Incentives for short-run risk taking
Incentives to move assets off balance

sheet

Maturity mismatches
Weaknesses in supervision and

regulation

Moral hazard

Powerful domino effects and feedback loops when bubbles pop

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Depth and global span of the crisis unprecedented after WWII

Trough in the contraction
f GDP (4.5%) well below

the average of 113 episodes of financial distress between 1980 and 2008, as compiled by IMF (2008)

Slower rebound of

consumption growth in the current crisis.

Housing and business

investment also more affected in the current crisis.

GDP

6
4
2

2 4 6 t-12 t-8 t-4 t = 0 t+4 t+8 t+12

% year on year growth

113 historical crises (median) EA (current crisis) UK (current crisis) US (current crisis) Note: y-o-y grow th rates during tw elve quarters before and after the beginning (0) of a finanical stress episode. Dotted lines refer to

forecasts. Sources: IMF, OECD, European Commission.

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Historical perspectives

Great Depression the common benchmark
It served also as a great lesson for policy

intervention in the current crisis

– Financial meltdown avoided – Monetary policy eased aggressively – Substantial fiscal stimulus – No large scale protectionism

What perspectives can even longer-term

comparisons yield?

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(de)stabilisers

Speed and quality of information transfer

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Empirical basis

Especially when comparing with the pre-

WWI era, quality of the data cannot easily bear the weight of the analysis

Disparate sources hinder comparability
Chronology of episodes of financial stress

relatively well documented (Reinhart and Rogoff, Bordo)

But link with real economy and financial

sector impact sometimes difficult to make

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Comparing the downturn in economic activity

Graph I.2 .1: G DP levels during three globa l crise s 80 85 90 95 100 105 110 115 120 125 1 2 3 4 5 6 7 8 9 10 11 1907=100 1929=100 2007=100

Source: Smits, W oltjer and Ma (2009), Maddison (2007), W orld Economic Outlook Database, Interim forecast of September 2009 and own calculations.

2007-2014 192 9-19 39 1907-1913

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comparisons with the 1930s

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Output rebounds much faster in current episode

Graph I.2.3: World industrial output during the Great Depression and the current crisis 60 65 70 75 80 85 90 95 100 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 Months into the crisis

June 1929=100 April 2008=100

June 1929 - August 1933

April 2008 - December 2009

Source: League of Nations Monthly Bulletin of Statistics from Eichengreen and O'Rourke (2009) and ECFIN database.

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Trade patterns

Fall in world trade less, but much faster in 2008-2009 than in the 1930s

Graph I.2.4:The decline in world trade during the crisis of 1929-1933

60 70 80 90 100 110 Jun (1929 = 100) Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May

Notes: Light blue from Jun-1929 to Jul-1932 (minimum Jun-1929); dark blue from Aug-1932. Source: League of Nations Monthly Bulletin of Statistics from Eichengreen and O'Rourke (2009).

Graph I.2.5: The decline in world trade during the crisis of 2008-2009

60 70 80 90 100 110 Apr (2008 = 100) May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

Notes: Light blue from April 2008 to Mar 2009 (minimum Feb-2009); dark blue from Apr-2009. Source: CPB, Commission services calculations.

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Protectionist backlash in the 1930s

5 10 15 20 25 30 1865 1885 1905 1925 1945 1965 1985

Source: Clemens and Williamson (2001). Comment: As a rule average tariff rates are calculated as the total revenue from import duties divided by the value of total imports in the same year. See the data appendix to Clemens and Williamson (2001).

World War I World War II

World average of own tariffs for 35 countries, 1865- 1996, un-weighted average, per cent of GDP

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Monetary contraction avoided

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Fiscal policy adjustments of different order of magnitude

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Labour market adjustment less strong in current episode

Graph I.2.6: Unemployment rates during the Great Depression and the present crisis in the US and Europe

5 10 15 20 25 30 35 40 1 2 3 4 5 6 7 8 9 10 11 Years into the crisis %

USA USA - forecast Europe** Euro area - forecast

Note: * 1929-1939 unemployment rates in industry. ** BEL, DEU, DNK, FRA, GBR, NLD, SWE. Source: Mitchell (1992), Garside (2007) and AMECO.

1929-1939* 2008-2011

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Crisis of 1907 emerges as the closest comparable episode in the classical Gold Standard era in some respects - but not all

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Stylised cyclical chronology

Real GDP growth (%); source: A Maddison database

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6
4
2

2 4 6 8 10 1871 1876 1881 1886 1891 1896 1901 1906 1911 1916 1921 1926 1931 1936 advanced Western economies Latin America

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Relatively stable monetary ratios to GDP

Ratios to GDP (%) 1880-1913

source: Flandreau and Zumer 4 8 12 16 20 1880: 1883: 1886: 1889: 1892: 1895: 1898: 1901: 1904: 1907: 1910: 1913: M1 reserves government revenue

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Fiscal deficits contained, public debts less so, but declining

Fiscal ratios to GDP (%) 1880-1913

source: Flandreau and Zumer

1.0
0.8
0.6
0.4
0.2

0.0 0.2 0.4 0.6 1880: 1883: 1886: 1889: 1892: 1895: 1898: 1901: 1904: 1907: 1910: 1913: 10 20 30 40 50 60 70 80 90 public deficit public debt (rhs)

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Share prices

Dow Jones Industrial share price index preceding peak year (t0) = 100

40 80 120 160 200 240 t 1 2 3 4 5 6 peak 1907 peak 1929 peak 1980 peak 2000 peak 2008

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Linking back to the current policy challenges

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Rise in size of government increased fiscal multipliers

Advanced economies - government expenditure ratio to GDP (%)

source: Tanzi & Schuknecht, Flandreau & Zumer, Commission services

10 20 30 40 50 60 1870 1913 1920 1937 1960 1996 2001 2003 2008 2011

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An illustration of crisis control and mitigation: unprecedented fiscal stimulus in 2009…

Fiscal stimulus in 2009

0.0 0.5 1.0 1.5 2.0 2.5 3.0

BG DK HU LT LV MA SK CY EE EL IT NL IE BE FR PT FI PO CZ EA EU SL LU SE DE UK AT ES US

% of GDP

Fiscal impulse Impact lower extreme: if stimulus is permanent Impact upper extreme: if stimulus is temporary and accommodated Impact if stimulus is temporary Source: European Commission.

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Public debt is higher and rises much faster in current crisis

Advanced economies - gross government debt ratio to GDP (%)