Transcript of a Press Briefing by IMF Research Director Olivier Blanchard on “From Recession to Recovery: How Soon and How Stronger” and “How Linkages Fuel the Fire: The Transmission of Financial Stress from Advanced to Emerging Economies”, with Marco Terrones and Stephan Danninger of the IMF’s Research Department
Washington, D.C.
Thursday, April 16, 2009 Webcast of the press briefing
MR. MURRAY: Hi. Good day. I’m William Murray, Chief of Media Relations at the International Monetary Fund.
This is a briefing on the analytic chapters of the latest World Economic Outlook. This briefing and the contents of the Chapters 3 and 4 are embargoed for release at 10:30 a.m. Washington time, 14:30 GMT today.
Let me briefly introduce the panelists: Olivier Blanchard, Economic Counsellor and Director of Research, Marco Terrones and Stephan Danninger, both principal authors of Chapters 3 and 4 of the World Economic Outlook.
Olivier will have some opening remarks, and then we’ll go from there.
Olivier?
MR. BLANCHARD: Thank you, Bill.
As most of you know, the World Economic Outlook is composed of two parts. The first is the analysis of economic trends around the world. This will be presented, as Bill indicated, next week. And the other is a set of in-depth studies of particular aspects of the current evolutions which we think of particular interest.
Given the time it takes to prepare these studies, one has to guess six months or a year in advance what the hot topics will be. I think this year we had either some luck or some nose, but we’ve chosen two very important topics for such study.
The first one is the nature of the recoveries following recessions, clearly a central issue in today’s environment. We ask whether the speed of recovery depends on the type of shocks that created the recession in the first place. We’re asking, for example, whether if the recession is due to a financial shock, the recovery is slower or faster, whether if the recession is synchronized across countries, it is harder for all countries to get out of it together or whether it doesn’t make any difference.
Clearly, both aspects are relevant today. This crisis is very much originating in the financial sector. It is very synchronized. Therefore, the results of the study are extremely important, and, as you will see, they are fairly sobering.
Without further ado, let me just give the microphone to Marco Terrones who was in charge of the study, and he will give you details.
MR. TERRONES: Thank you, Olivier.
Chapter 3 of the World Economic Outlook, entitled “From Recession to Recovery: How Soon and How Strong”, examines more than 120 recessions and recoveries that have taken place across all advanced economies since 1960. It marshals evidence on the past to examine how the current recession and forthcoming recoveries may unfold and what difference policy can make.
To do so, the chapter distinguishes between recessions associated with financial shocks and other recessions. It also distinguishes between recessions that were highly synchronized across countries and recessions that were country or regionally specific. Lastly, it examines the role of countercyclical policies in shortening recessions and in strengthening recoveries.
So, what did we find? First, relative to other recessions, recessions associated with financial crisis are longer and more severe. Also, recoveries to pre-crisis output levels from such recessions are typically slower. On average, financial crisis-associated recessions last one and a half years or two quarters longer than other recessions. Furthermore, after the start of such recessions, it takes almost three years to get back to pre-recession output levels, which is more than one and a half years longer than in the case of other recessions.
These results are illustrated in the first chart that is shown there. In there, we describe the different types of recessions and associated recoveries. And, in there, there is the duration of each of these recessions and recoveries.
Second, we found that globally synchronized recessions are also longer and deeper than other recessions and recoveries, and they are more sluggish. So this is sobering evidence for today, given that we have both financial sector driven and globally synchronized recessions. It turns out that in our sample such a combination is rare, and the past suggests that such recessions last almost two years and that it takes over three and a half years for economies to return to pre-crisis output levels.
We also investigated whether macroeconomic policies help mitigate recessions and strengthen recoveries. Our findings suggest that expansionary macroeconomic policies have been associated with shorter recessions and stronger recoveries. Also, while the effects of monetary policy have weakened the recessions associated with financial crisis, that of fiscal policy is to strengthen.
The next chart illustrates how the probability of remaining in recessions falls when fiscal stimulus is implemented as shown by the blue relative to the red line. The red line shows you the probability of remaining in recession without policies and the blue line is the one that represents the probability of remaining in recessions after implementing fiscal policies.
We also find evidence that suggests that the impact of fiscal policy on the strength of the recovery is smaller for economies that have high public debt levels.
To conclude, the current recessions are likely to be unusually severe, and the forthcoming recoveries sluggish. Aggressive monetary and, particularly, fiscal policies could strengthen and bring forward recoveries.
Thank you.
MR. BLANCHARD: Thank you, Marco.
The second study is equally topical. It is on the transmission of financial stress from advanced economies to emerging market economies. I don’t need to convince you that this is also one of the central aspects of the crisis today, and the questions here are many: Why are some countries more affected than others? Does it depend on the type of financial relation that they had with advanced countries, for example mostly banking relations or more anonymous capital flows? Does it depend on the initial conditions in the country? Again, here, our approach has been to look at the large number of cases in the past, and the results of that study are going to be presented by Stephan Danninger.
MR. DANNINGER: The chapter on how economic and financial linkages fuel the fire studies the transmission of financial stress from advanced to emerging economics. Looking beyond advanced economies, what we’re trying to understand is how severe the current crisis is relative to the past, how it spreads across the world and what the implications are for capital flows going forward.
Now to answer these questions, we developed a new financial stress index for emerging economies. It builds on a similar index for advanced economies that was published in the fall in Chapter 4 of the WEO, and it provides a measure basically of the intensity of financial stress in emerging economies.
You can see this index in the following chart. The financial stress in advanced economies, the red line, has reached record levels, truly, compared to the past. It’s truly larger than anything we’ve seen in the past.
Financial stress in the emerging economies, these are the blue bars. They also surpass the peaks seen during the Asian crisis, but it’s not in a different ballpark.
Also, if you look at the very end, the very right end of the chart, you can see that there is some tapering off which offers some glimmer of hope that the stress is receding.
Now on stress transmission, we find that the stress in emerging economies typically increases almost one for one with the stress in advanced economies, and this also holds true for the current crisis. That said, there’s clearly some regional variation. As you know, emerging Europe was hit especially hard while economies in Latin America weathered the first wave of the stress fairly well.
The main factors accounting for this variation is the strength of financial linkages that emerging economies have with advanced economies. So countries with higher foreign liabilities tend to experience a stronger pass-through of stress from advanced economies.
The twist in the current crisis is that bank lending linkages are the main driver, and it’s not what one might expect, the more protracted investment links which had driven the Asian crisis.
This is illustrated in the second chart. The bank lending linkages are quite large for all emerging economies. Western European banks, these are the orange or yellow bars, hold the largest share of the liabilities in emerging economies. And, the main recipient region, that’s the tallest bar, the second from the left, is emerging Europe. So, in a sense, it’s no surprise therefore that emerging Europe was the first region to be hit hard by the crisis.
What are the implications for capital flows? Historical evidence suggests that a fast recovery of capital flows is unlikely. The reason is the key role of banking sector stress in the current crisis in advanced economies. Evidence from past systemic banking stress in the U.S. in the early 1980s and the Asian crisis show that the decline in capital flows to emerging economies can be large and long-lasting.
This is illustrated in the next chart. The green bars show the capital flows after the crisis and that they remain below pre-crisis levels for many years.
But, more importantly, the effects on economic growth are also large. You see the trend line which is the red line. This would be the level of output after the crisis based on the trend, and the actual one is the black line which is much lower.
So, an important question is whether countries can protect themselves against the transmission of a large and financial shock in advanced economies, and the answer to that is mixed. Having the budget and external balances in order does not insulate economies from major financial stress in advanced economies. However, it may help mitigate the impact of the stress on output because it allows for stronger domestic response.
The bottom line is that while international financial integration brings opportunities for future growth, it comes with risks for emerging economies to suffer contagion from advanced economy stress. This underlines the need for policy frameworks in emerging economies to be strong, and it motivates the recent initiatives here in the Fund to introduce more flexible credit lines for good performers which should help mitigate this contagion.
MR. BLANCHARD: Thank you, Stephan.
QUESTION: A question on the recovery study: Does that study indicate anything about the current crisis, how long, when the recovery will start and how long it will take for it to take place?
And a question for the emerging market study: The tapering off in stress, it seems to be in both advanced and emerging economies. Is that correct? In what areas are you seeing that?
Thank you.
MR. TERRONES: Regarding the recovery, when will it start, based on past experience, what we could say is that recessions associated with financial crisis that at the same time are highly synchronized last almost two years. That’s where we have found in this study.
However, as we mentioned in the presentation, these events are very rare. There were only six of such recessions. So, therefore, this number has to be taken with a grain of salt.
More evidence could be to just look at what has happened with the recessions associated with financial crisis. In that case, the recessions last around one year and a half. Okay? So it’s likely shorter recessions.
With regard to the recovery, it takes almost three years and a half for output to get to the level, to the previous peak level in the case where you have recessions associated with financial crisis and that are highly synchronized. Okay? But again, that’s based on the six observations I mentioned to you.
In the larger case, where you have recessions associated with financial crisis, it takes three years to go from the pre-crisis peak output.
I don’t know if that answers your question.
QUESTION: Then related to the current crisis, is there a start date for the global crisis or do we just have to look at each individual economy and make our own assumption?
MR. TERRONES: Yes, I would say you have to look at each individual economy.
MR. MURRAY: Stephan?
MR. DANNINGER: Yes, the question about the tapering off of stress, indeed, it’s a reduction that you can see the data go up to January, February. I think that’s the latest that we have in our index.
You asked for the main components. Well, we’ve seen a coming down on equity markets in terms of volatility. Spreads were high, but they have come down a little bit, both in advanced and emerging economies. But I think the main point to make here is that the tapering off is from a stress level that was extremely high to one that is still very high. So we don’t see any normalization yet, but the direction is certainly moving towards more stability.
MR. MURRAY: Thanks, Stephan.
I’m going to take a question from the Media Briefing Center.
The question is: The study on financial stress says that capital flows to emerging markets will continue to decline. Will this lead in the long term to fundamental changes in the way emerging markets and companies finance themselves, particularly with less reliance on foreign capital?
MR. DANNINGER: I think what this study can quite firmly say is that recovery won’t be quick and fast as we’ve seen as in a regular standard recession or when individual countries go through homegrown crisis and there is a decline in capital flows. In fact, what you see is that following large and systemic crises, and we looked more carefully at the case of Japan in the 1990s, that the decline in capital flows was quite drawn out. I think it lasted about eight years until the region as a whole and emerging Asia received again positive capital inflows.
So this implies that there is indeed a long, possibly very long period of transition ahead, and possibly this is going to have adjustments on the financing side. So, to sum up, it’s probably not unlikely that there will be differences in the financing for emerging economies.
QUESTION: People are looking now to where the recovery could come from. And when you look at your studies on both advanced economies and the financial stress, is your feeling that the issues in the emerging economies will take much longer for a recovery than those in advanced countries? So, therefore, the pickup would come instead in advanced economies first.
MR. TERRONES: This is an important question, where the recovery will come from. Indeed, the study shows evidence that in advanced economies there is going to happen, to take place, a process of deleveraging -- or is taking place, a process of deleveraging -- and households are increasing their savings rates. Therefore, the domestic demand is going to be a little weak.
In order to compensate for this, policies are very important. The implementations of monetary and fiscal policies are key to the strength of recovery, and that’s one of the main findings that we have in the chapter. Both policies help to strengthen the recovery.
Having said that, some countries have more room than other countries in terms to implement their fiscal policies. There are countries with high levels of public debt than other countries, and therefore the framing of these policies have to be done, case by case.
In this, in the current conjuncture, it happens that also we have a highly synchronized recession. That means that the external demand is not going to be there to pull economies as in the past. One key driver of recoveries in the cases of recessions with financial crisis was the external sector. But right now, the external sector is not going to be there until the major economies start to recover and so the more reason for these countries to take the relevant policies to bring back recovery.
MR. DANNINGER: Maybe just to add on, clearly, given that capital flows are important an ingredient for emerging economies, it’s most likely going to be the case that the recovery will not be initiated or will not be possible without also recovery first taking place in advanced economies.
So the one thing that we learned from our study is that you can have very sound policies in place, but that does not protect you against the crisis in advanced economies. And, vice-versa, these polices, if you have them in place, they do help you in the recovery, but there is certainly need for support from the external side, and that will have to come from a recovery in the advanced economies.
MR. BLANCHARD: Let me add a word here. Emerging market economies are affected by two main shocks. The first one is a drop in exports, and the other is the net capital outflows.
Exports will turn around when the export markets turn around, thus when the advanced countries are recovering. And then when they do, exports will follow, not before and not long after.
On the net capital outflows, what Stephan has been showing is that it’s likely to take a long time for banks to go back in those markets in the way they were in before the crisis. And so, even if the banking system is slowly repaired in advanced countries, it is going to take quite a while before we see the return of capital outflows.
So, in that sense, your question gets to the right point: It may take quite a while.
QUESTION: This week, Russian Finance Minister Aleksy Kudrin said that it could last 50 years, a half century, for Russia to recover. Do we have any history of such an example for 50 years recovery?
MR. TERRONES: Well, in the study, we examined the case of advanced economies, and the larger or the longest recovery we have observed, around five to six years. I don’t recall having seen a 50 years recovery process. Expansions, you can see expansions of that magnitude, of that length, but not recoveries.
MR. BLANCHARD: Well, let me just say that this study is based only on post-war evidence, and so leaves out the Great Depression. Clearly, this was a case of a very long recession followed by a long recovery.
MR. MURRAY: Thank you, Olivier.
I’m going to turn to the Media Briefing Center again. This is a question. It’s more specific about the Philippines, but it is also a question about policy response among countries with high debt to GDP ratios.
The question is: Since these chapters say that fiscal stimulus packages are less effective for emerging countries with high debt to GDP ratios, what can be the appropriate policy response for countries like the Philippines?
I think the question is more about high debt to GDP ratio countries.
MR. TERRONES: The finding that is referred in the question is found in the context of the advanced economies. Philippines was not part of the sample. However, the principle there is that it’s important to have, that the issues of fiscal sustainability are important for the effects that they have in the strength of the recovery. That’s the main lesson that’s drawn from that result as opposed to specific numbers that are provided.
And, if the Philippines has a problem with fiscal sustainability, then the effectiveness of fiscal policy will deteriorate.
QUESTION: Two questions if I may: Looking at this crisis, I mean there is a very important housing component here, and I wonder if you looked at that, whether there is housing bubble there, whether it prolongs the recession or not. I mean what kind of effect that has and what can you say about the crisis because of that element.
And the second is a clarification. When you, Mr. Terrones, said it takes three and a half years to get to the previous output. What is the starting point?
Like, for example, in the United States, the recession started in December, 2007. So where would be the three and a half years of just coming back to the previous output?
Thank you.
MR. TERRONES: When we have examined the recessions associated with financial crisis, we have looked at the initial conditions that led to these recessions, and one of the findings that we report in the chapter is that there was evidence of a large credit expansion in these economies and also there was a boom in asset prices including houses. So it was a precondition to the crisis.
So we do not neglect looking at that issue, and indeed it was one of the preconditions that led to this crisis.
The other thing we noticed there is that household balance sheets deteriorated in the run-up to the recession.
Regarding your second questions of when was the recession in the United States started? According to the National Bureau, it started in December, 2007. In the study, what we do is apply a common to all the countries, and our dating starts in June, 2008.
So, obviously, each dating has some problems. So you have to see which one. History will determine which dating was the more appropriate.
QUESTION: A follow-up: So if you think that the recession, according to your standard, started in June, 2008, and you’re saying that this kind of recession lasts almost 2 years, then you are talking about the United States being in recession until June, 2010. Is that correct?
MR. BLANCHARD: Let me intervene here. This study does not try to do forecasts. It is looking at average behavior in past recessions. All recessions are different in some ways, and this one is no exception. You’ll have to wait until next week to actually get our forecasts.
MR. TERRONES: Also, let me complement to what Olivier just said. It’s very important, the policies that are implemented. So these durations are subject to the policies that the countries adopt. In the chapter, we show that countries that adopt aggressive policies, particularly fiscal policies, tend to shorten the duration of the recessions. So that’s an important finding that we also report in the chapter.
QUESTION: In the report, you talk about the importance of fiscal expansion in advanced economies to bring about a recovery. If a country like the U.S. considers a second stimulus package and there are other countries, other advanced economies that haven’t put forth any sort of fiscal expansion or stimulus package, can that sort of counteract no action by a certain country? And if the U.S. sort of doubles its efforts for fiscal expansion, will that still help the advanced economies in general towards their recovery?
MR. TERRONES: Obviously, if the United States implements fiscal policy, it’s going to help to bring, to reduce the duration of recessions. But also, in the chapter, we note that given the synchronized nature of the current recession, it’s very important that other countries also put in place policies that help to bring up, to bring forward the recoveries in these countries.
Remember that in the past, as I mentioned, one key driver for the recovery of recessions associated with financial crisis was external demand. So it’s very important that countries around the world implement policies so that that external demand starts pulling everybody out of the recession.
MR. MURRAY: I just want to remind people we want to try to avoid country-specific forecasting right now. We’ll get to it next week. World Economic Outlook Chapters 1 and 2, the forecasts, will get into much more detail.
QUESTION: So, Mr. Blanchard, is the recovery started is my first question. Do you see any sign of the beginning of recovery? This is not a forecast. I’m asking for the present moment, in advanced economies.
Since I follow your report every six months, I would like to know what the IMF has learned from the last of these reports you gave to us six months ago.
MR. MURRAY: I think those are good questions, happy to answer them, but I think we’re going to take care of those next week.
QUESTION; On the analytical chapter, I’m serious. I’m asking what’s the difference with what you said in the last meeting when the analytical chapters started saying this recession is different? It’s unique. It’s going to be long.
MR. MURRAY: Why is this recession more unique than six months ago?
QUESTION: What have you learned in this period?
MR. MURRAY: That’s a good question.
MR. DANNINGER: I mean one of the things that the transmission tells us and that was not quite clear is how fast emerging economies do respond to financial stress in advanced economies. Specifically, when we ran our analysis, the response and the data is within one or two months.
So, once the crisis hit in September, October, the last time around when the chapter came out, there was an expectation that it would affect emerging economies, but it turns out that it’s actually consistent with the past. In a sense, the current crisis is, in that sense, similar.
Now, when you look at the level and the scale of financial stress, it’s a multiple of the past. But, again, if you look at the relationship, the impulse, the size of the crisis in advanced economies is a multiple larger and the response is also a multiple larger. So that relationship still holds up.
I think what we take away from this is it’s clearly a larger scale event, but patterns of the past do hold. And to the extent that emerging economies have gone through crises, in a way, the pattern of drying up of capital flows are similar to the past.
MR. MURRAY: Thanks, Stephan.
MR. TERRONES: Compared to six months ago, now we have a better sense of the source of the recession. In the chapter, we mentioned that these recessions have two key aspects. The first aspect is that recessions are associated with financial crisis, and the second aspect is recessions are highly synchronized. So, therefore, the analysis has focused on those types of recessions, and we have learned both the duration and the costs that these recessions have.
So now we have a better sense on how costly these could be and how long it will take to come out of the recession.
MR. MURRAY: Thanks, Marco.
QUESTION: You’ve heard a lot of developing countries making the point that those that had limited exposure to banks and advanced economies weren’t hurt as bad. The question now is whether that is going to be a choice now for a lot of these countries, developing countries, saying: Well, look what happened in that crisis. Those that limited their exposure were better off.
Is there some risk of this, do you think, of happening?
And a follow-up on that one would be the issue of green shoots. Larry Summers, I think, coined that phrase. I’m not sure if it’s a different phrase. But have you seen in previous recessions that are attached financial crisis where there have been signs of green shoots that have then died and then emerged again?
MR. BLANCHARD: One question is to Stephan. Maybe on the other one, Marco can say something.
MR. DANNINGER: I think what the current crisis just brings out very clearly and to answer your question affirmative is that there are risks associated with financial integration, but international financial integration is not a byproduct. It’s actually very much an ingredient for growth and acceleration, especially in terms of catching up or moving towards advanced economy levels of income for emerging economies.
So you have on the one side this, I think, very important and continuing process of financial integration, but, as this crisis manifests, it’s associated with risks. And the policies and frameworks that should be in place for countries that have or did not have any homegrown vulnerabilities should be a system of protection at hand that provides them some buffer if the crisis hits.
I think one of the initiatives at the Fund, the flexible credit line, is one of these arrangements that would help countries weather these storms.
MR. TERRONES: Regarding to the green shoots, I don’t recall of countries going with these deep recessions. I don’t recall.
MR. MURRAY: Okay. I think we’re going to wrap this up now. Again, thank you for coming.
We have about roughly an hour to go before the embargo on this briefing and the contents of the documents expires. Again, that’s 10:30 a.m. Washington time, 14:30 GMT.
Next week, April 22nd, here at IMF Headquarters, Mr. Blanchard and the Research Department will be briefing on the World Economic Outlook forecasts. That’s Chapters 1 and 2. We look forward to seeing you then.
MR. MURRAY: Hi. Good day. I’m William Murray, Chief of Media Relations at the International Monetary Fund.
This is a briefing on the analytic chapters of the latest World Economic Outlook. This briefing and the contents of the Chapters 3 and 4 are embargoed for release at 10:30 a.m. Washington time, 14:30 GMT today.
Let me briefly introduce the panelists: Olivier Blanchard, Economic Counsellor and Director of Research, Marco Terrones and Stephan Danninger, both principal authors of Chapters 3 and 4 of the World Economic Outlook.
Olivier will have some opening remarks, and then we’ll go from there.
Olivier?
MR. BLANCHARD: Thank you, Bill.
As most of you know, the World Economic Outlook is composed of two parts. The first is the analysis of economic trends around the world. This will be presented, as Bill indicated, next week. And the other is a set of in-depth studies of particular aspects of the current evolutions which we think of particular interest.
Given the time it takes to prepare these studies, one has to guess six months or a year in advance what the hot topics will be. I think this year we had either some luck or some nose, but we’ve chosen two very important topics for such study.
The first one is the nature of the recoveries following recessions, clearly a central issue in today’s environment. We ask whether the speed of recovery depends on the type of shocks that created the recession in the first place. We’re asking, for example, whether if the recession is due to a financial shock, the recovery is slower or faster, whether if the recession is synchronized across countries, it is harder for all countries to get out of it together or whether it doesn’t make any difference.
Clearly, both aspects are relevant today. This crisis is very much originating in the financial sector. It is very synchronized. Therefore, the results of the study are extremely important, and, as you will see, they are fairly sobering.
Without further ado, let me just give the microphone to Marco Terrones who was in charge of the study, and he will give you details.
MR. TERRONES: Thank you, Olivier.
Chapter 3 of the World Economic Outlook, entitled “From Recession to Recovery: How Soon and How Strong”, examines more than 120 recessions and recoveries that have taken place across all advanced economies since 1960. It marshals evidence on the past to examine how the current recession and forthcoming recoveries may unfold and what difference policy can make.
To do so, the chapter distinguishes between recessions associated with financial shocks and other recessions. It also distinguishes between recessions that were highly synchronized across countries and recessions that were country or regionally specific. Lastly, it examines the role of countercyclical policies in shortening recessions and in strengthening recoveries.
So, what did we find? First, relative to other recessions, recessions associated with financial crisis are longer and more severe. Also, recoveries to pre-crisis output levels from such recessions are typically slower. On average, financial crisis-associated recessions last one and a half years or two quarters longer than other recessions. Furthermore, after the start of such recessions, it takes almost three years to get back to pre-recession output levels, which is more than one and a half years longer than in the case of other recessions.
These results are illustrated in the first chart that is shown there. In there, we describe the different types of recessions and associated recoveries. And, in there, there is the duration of each of these recessions and recoveries.
Second, we found that globally synchronized recessions are also longer and deeper than other recessions and recoveries, and they are more sluggish. So this is sobering evidence for today, given that we have both financial sector driven and globally synchronized recessions. It turns out that in our sample such a combination is rare, and the past suggests that such recessions last almost two years and that it takes over three and a half years for economies to return to pre-crisis output levels.
We also investigated whether macroeconomic policies help mitigate recessions and strengthen recoveries. Our findings suggest that expansionary macroeconomic policies have been associated with shorter recessions and stronger recoveries. Also, while the effects of monetary policy have weakened the recessions associated with financial crisis, that of fiscal policy is to strengthen.
The next chart illustrates how the probability of remaining in recessions falls when fiscal stimulus is implemented as shown by the blue relative to the red line. The red line shows you the probability of remaining in recession without policies and the blue line is the one that represents the probability of remaining in recessions after implementing fiscal policies.
We also find evidence that suggests that the impact of fiscal policy on the strength of the recovery is smaller for economies that have high public debt levels.
To conclude, the current recessions are likely to be unusually severe, and the forthcoming recoveries sluggish. Aggressive monetary and, particularly, fiscal policies could strengthen and bring forward recoveries.
Thank you.
MR. BLANCHARD: Thank you, Marco.
The second study is equally topical. It is on the transmission of financial stress from advanced economies to emerging market economies. I don’t need to convince you that this is also one of the central aspects of the crisis today, and the questions here are many: Why are some countries more affected than others? Does it depend on the type of financial relation that they had with advanced countries, for example mostly banking relations or more anonymous capital flows? Does it depend on the initial conditions in the country? Again, here, our approach has been to look at the large number of cases in the past, and the results of that study are going to be presented by Stephan Danninger.
MR. DANNINGER: The chapter on how economic and financial linkages fuel the fire studies the transmission of financial stress from advanced to emerging economics. Looking beyond advanced economies, what we’re trying to understand is how severe the current crisis is relative to the past, how it spreads across the world and what the implications are for capital flows going forward.
Now to answer these questions, we developed a new financial stress index for emerging economies. It builds on a similar index for advanced economies that was published in the fall in Chapter 4 of the WEO, and it provides a measure basically of the intensity of financial stress in emerging economies.
You can see this index in the following chart. The financial stress in advanced economies, the red line, has reached record levels, truly, compared to the past. It’s truly larger than anything we’ve seen in the past.
Financial stress in the emerging economies, these are the blue bars. They also surpass the peaks seen during the Asian crisis, but it’s not in a different ballpark.
Also, if you look at the very end, the very right end of the chart, you can see that there is some tapering off which offers some glimmer of hope that the stress is receding.
Now on stress transmission, we find that the stress in emerging economies typically increases almost one for one with the stress in advanced economies, and this also holds true for the current crisis. That said, there’s clearly some regional variation. As you know, emerging Europe was hit especially hard while economies in Latin America weathered the first wave of the stress fairly well.
The main factors accounting for this variation is the strength of financial linkages that emerging economies have with advanced economies. So countries with higher foreign liabilities tend to experience a stronger pass-through of stress from advanced economies.
The twist in the current crisis is that bank lending linkages are the main driver, and it’s not what one might expect, the more protracted investment links which had driven the Asian crisis.
This is illustrated in the second chart. The bank lending linkages are quite large for all emerging economies. Western European banks, these are the orange or yellow bars, hold the largest share of the liabilities in emerging economies. And, the main recipient region, that’s the tallest bar, the second from the left, is emerging Europe. So, in a sense, it’s no surprise therefore that emerging Europe was the first region to be hit hard by the crisis.
What are the implications for capital flows? Historical evidence suggests that a fast recovery of capital flows is unlikely. The reason is the key role of banking sector stress in the current crisis in advanced economies. Evidence from past systemic banking stress in the U.S. in the early 1980s and the Asian crisis show that the decline in capital flows to emerging economies can be large and long-lasting.
This is illustrated in the next chart. The green bars show the capital flows after the crisis and that they remain below pre-crisis levels for many years.
But, more importantly, the effects on economic growth are also large. You see the trend line which is the red line. This would be the level of output after the crisis based on the trend, and the actual one is the black line which is much lower.
So, an important question is whether countries can protect themselves against the transmission of a large and financial shock in advanced economies, and the answer to that is mixed. Having the budget and external balances in order does not insulate economies from major financial stress in advanced economies. However, it may help mitigate the impact of the stress on output because it allows for stronger domestic response.
The bottom line is that while international financial integration brings opportunities for future growth, it comes with risks for emerging economies to suffer contagion from advanced economy stress. This underlines the need for policy frameworks in emerging economies to be strong, and it motivates the recent initiatives here in the Fund to introduce more flexible credit lines for good performers which should help mitigate this contagion.
MR. BLANCHARD: Thank you, Stephan.
QUESTION: A question on the recovery study: Does that study indicate anything about the current crisis, how long, when the recovery will start and how long it will take for it to take place?
And a question for the emerging market study: The tapering off in stress, it seems to be in both advanced and emerging economies. Is that correct? In what areas are you seeing that?
Thank you.
MR. TERRONES: Regarding the recovery, when will it start, based on past experience, what we could say is that recessions associated with financial crisis that at the same time are highly synchronized last almost two years. That’s where we have found in this study.
However, as we mentioned in the presentation, these events are very rare. There were only six of such recessions. So, therefore, this number has to be taken with a grain of salt.
More evidence could be to just look at what has happened with the recessions associated with financial crisis. In that case, the recessions last around one year and a half. Okay? So it’s likely shorter recessions.
With regard to the recovery, it takes almost three years and a half for output to get to the level, to the previous peak level in the case where you have recessions associated with financial crisis and that are highly synchronized. Okay? But again, that’s based on the six observations I mentioned to you.
In the larger case, where you have recessions associated with financial crisis, it takes three years to go from the pre-crisis peak output.
I don’t know if that answers your question.
QUESTION: Then related to the current crisis, is there a start date for the global crisis or do we just have to look at each individual economy and make our own assumption?
MR. TERRONES: Yes, I would say you have to look at each individual economy.
MR. MURRAY: Stephan?
MR. DANNINGER: Yes, the question about the tapering off of stress, indeed, it’s a reduction that you can see the data go up to January, February. I think that’s the latest that we have in our index.
You asked for the main components. Well, we’ve seen a coming down on equity markets in terms of volatility. Spreads were high, but they have come down a little bit, both in advanced and emerging economies. But I think the main point to make here is that the tapering off is from a stress level that was extremely high to one that is still very high. So we don’t see any normalization yet, but the direction is certainly moving towards more stability.
MR. MURRAY: Thanks, Stephan.
I’m going to take a question from the Media Briefing Center.
The question is: The study on financial stress says that capital flows to emerging markets will continue to decline. Will this lead in the long term to fundamental changes in the way emerging markets and companies finance themselves, particularly with less reliance on foreign capital?
MR. DANNINGER: I think what this study can quite firmly say is that recovery won’t be quick and fast as we’ve seen as in a regular standard recession or when individual countries go through homegrown crisis and there is a decline in capital flows. In fact, what you see is that following large and systemic crises, and we looked more carefully at the case of Japan in the 1990s, that the decline in capital flows was quite drawn out. I think it lasted about eight years until the region as a whole and emerging Asia received again positive capital inflows.
So this implies that there is indeed a long, possibly very long period of transition ahead, and possibly this is going to have adjustments on the financing side. So, to sum up, it’s probably not unlikely that there will be differences in the financing for emerging economies.
QUESTION: People are looking now to where the recovery could come from. And when you look at your studies on both advanced economies and the financial stress, is your feeling that the issues in the emerging economies will take much longer for a recovery than those in advanced countries? So, therefore, the pickup would come instead in advanced economies first.
MR. TERRONES: This is an important question, where the recovery will come from. Indeed, the study shows evidence that in advanced economies there is going to happen, to take place, a process of deleveraging -- or is taking place, a process of deleveraging -- and households are increasing their savings rates. Therefore, the domestic demand is going to be a little weak.
In order to compensate for this, policies are very important. The implementations of monetary and fiscal policies are key to the strength of recovery, and that’s one of the main findings that we have in the chapter. Both policies help to strengthen the recovery.
Having said that, some countries have more room than other countries in terms to implement their fiscal policies. There are countries with high levels of public debt than other countries, and therefore the framing of these policies have to be done, case by case.
In this, in the current conjuncture, it happens that also we have a highly synchronized recession. That means that the external demand is not going to be there to pull economies as in the past. One key driver of recoveries in the cases of recessions with financial crisis was the external sector. But right now, the external sector is not going to be there until the major economies start to recover and so the more reason for these countries to take the relevant policies to bring back recovery.
MR. DANNINGER: Maybe just to add on, clearly, given that capital flows are important an ingredient for emerging economies, it’s most likely going to be the case that the recovery will not be initiated or will not be possible without also recovery first taking place in advanced economies.
So the one thing that we learned from our study is that you can have very sound policies in place, but that does not protect you against the crisis in advanced economies. And, vice-versa, these polices, if you have them in place, they do help you in the recovery, but there is certainly need for support from the external side, and that will have to come from a recovery in the advanced economies.
MR. BLANCHARD: Let me add a word here. Emerging market economies are affected by two main shocks. The first one is a drop in exports, and the other is the net capital outflows.
Exports will turn around when the export markets turn around, thus when the advanced countries are recovering. And then when they do, exports will follow, not before and not long after.
On the net capital outflows, what Stephan has been showing is that it’s likely to take a long time for banks to go back in those markets in the way they were in before the crisis. And so, even if the banking system is slowly repaired in advanced countries, it is going to take quite a while before we see the return of capital outflows.
So, in that sense, your question gets to the right point: It may take quite a while.
QUESTION: This week, Russian Finance Minister Aleksy Kudrin said that it could last 50 years, a half century, for Russia to recover. Do we have any history of such an example for 50 years recovery?
MR. TERRONES: Well, in the study, we examined the case of advanced economies, and the larger or the longest recovery we have observed, around five to six years. I don’t recall having seen a 50 years recovery process. Expansions, you can see expansions of that magnitude, of that length, but not recoveries.
MR. BLANCHARD: Well, let me just say that this study is based only on post-war evidence, and so leaves out the Great Depression. Clearly, this was a case of a very long recession followed by a long recovery.
MR. MURRAY: Thank you, Olivier.
I’m going to turn to the Media Briefing Center again. This is a question. It’s more specific about the Philippines, but it is also a question about policy response among countries with high debt to GDP ratios.
The question is: Since these chapters say that fiscal stimulus packages are less effective for emerging countries with high debt to GDP ratios, what can be the appropriate policy response for countries like the Philippines?
I think the question is more about high debt to GDP ratio countries.
MR. TERRONES: The finding that is referred in the question is found in the context of the advanced economies. Philippines was not part of the sample. However, the principle there is that it’s important to have, that the issues of fiscal sustainability are important for the effects that they have in the strength of the recovery. That’s the main lesson that’s drawn from that result as opposed to specific numbers that are provided.
And, if the Philippines has a problem with fiscal sustainability, then the effectiveness of fiscal policy will deteriorate.
QUESTION: Two questions if I may: Looking at this crisis, I mean there is a very important housing component here, and I wonder if you looked at that, whether there is housing bubble there, whether it prolongs the recession or not. I mean what kind of effect that has and what can you say about the crisis because of that element.
And the second is a clarification. When you, Mr. Terrones, said it takes three and a half years to get to the previous output. What is the starting point?
Like, for example, in the United States, the recession started in December, 2007. So where would be the three and a half years of just coming back to the previous output?
Thank you.
MR. TERRONES: When we have examined the recessions associated with financial crisis, we have looked at the initial conditions that led to these recessions, and one of the findings that we report in the chapter is that there was evidence of a large credit expansion in these economies and also there was a boom in asset prices including houses. So it was a precondition to the crisis.
So we do not neglect looking at that issue, and indeed it was one of the preconditions that led to this crisis.
The other thing we noticed there is that household balance sheets deteriorated in the run-up to the recession.
Regarding your second questions of when was the recession in the United States started? According to the National Bureau, it started in December, 2007. In the study, what we do is apply a common to all the countries, and our dating starts in June, 2008.
So, obviously, each dating has some problems. So you have to see which one. History will determine which dating was the more appropriate.
QUESTION: A follow-up: So if you think that the recession, according to your standard, started in June, 2008, and you’re saying that this kind of recession lasts almost 2 years, then you are talking about the United States being in recession until June, 2010. Is that correct?
MR. BLANCHARD: Let me intervene here. This study does not try to do forecasts. It is looking at average behavior in past recessions. All recessions are different in some ways, and this one is no exception. You’ll have to wait until next week to actually get our forecasts.
MR. TERRONES: Also, let me complement to what Olivier just said. It’s very important, the policies that are implemented. So these durations are subject to the policies that the countries adopt. In the chapter, we show that countries that adopt aggressive policies, particularly fiscal policies, tend to shorten the duration of the recessions. So that’s an important finding that we also report in the chapter.
QUESTION: In the report, you talk about the importance of fiscal expansion in advanced economies to bring about a recovery. If a country like the U.S. considers a second stimulus package and there are other countries, other advanced economies that haven’t put forth any sort of fiscal expansion or stimulus package, can that sort of counteract no action by a certain country? And if the U.S. sort of doubles its efforts for fiscal expansion, will that still help the advanced economies in general towards their recovery?
MR. TERRONES: Obviously, if the United States implements fiscal policy, it’s going to help to bring, to reduce the duration of recessions. But also, in the chapter, we note that given the synchronized nature of the current recession, it’s very important that other countries also put in place policies that help to bring up, to bring forward the recoveries in these countries.
Remember that in the past, as I mentioned, one key driver for the recovery of recessions associated with financial crisis was external demand. So it’s very important that countries around the world implement policies so that that external demand starts pulling everybody out of the recession.
MR. MURRAY: I just want to remind people we want to try to avoid country-specific forecasting right now. We’ll get to it next week. World Economic Outlook Chapters 1 and 2, the forecasts, will get into much more detail.
QUESTION: So, Mr. Blanchard, is the recovery started is my first question. Do you see any sign of the beginning of recovery? This is not a forecast. I’m asking for the present moment, in advanced economies.
Since I follow your report every six months, I would like to know what the IMF has learned from the last of these reports you gave to us six months ago.
MR. MURRAY: I think those are good questions, happy to answer them, but I think we’re going to take care of those next week.
QUESTION; On the analytical chapter, I’m serious. I’m asking what’s the difference with what you said in the last meeting when the analytical chapters started saying this recession is different? It’s unique. It’s going to be long.
MR. MURRAY: Why is this recession more unique than six months ago?
QUESTION: What have you learned in this period?
MR. MURRAY: That’s a good question.
MR. DANNINGER: I mean one of the things that the transmission tells us and that was not quite clear is how fast emerging economies do respond to financial stress in advanced economies. Specifically, when we ran our analysis, the response and the data is within one or two months.
So, once the crisis hit in September, October, the last time around when the chapter came out, there was an expectation that it would affect emerging economies, but it turns out that it’s actually consistent with the past. In a sense, the current crisis is, in that sense, similar.
Now, when you look at the level and the scale of financial stress, it’s a multiple of the past. But, again, if you look at the relationship, the impulse, the size of the crisis in advanced economies is a multiple larger and the response is also a multiple larger. So that relationship still holds up.
I think what we take away from this is it’s clearly a larger scale event, but patterns of the past do hold. And to the extent that emerging economies have gone through crises, in a way, the pattern of drying up of capital flows are similar to the past.
MR. MURRAY: Thanks, Stephan.
MR. TERRONES: Compared to six months ago, now we have a better sense of the source of the recession. In the chapter, we mentioned that these recessions have two key aspects. The first aspect is that recessions are associated with financial crisis, and the second aspect is recessions are highly synchronized. So, therefore, the analysis has focused on those types of recessions, and we have learned both the duration and the costs that these recessions have.
So now we have a better sense on how costly these could be and how long it will take to come out of the recession.
MR. MURRAY: Thanks, Marco.
QUESTION: You’ve heard a lot of developing countries making the point that those that had limited exposure to banks and advanced economies weren’t hurt as bad. The question now is whether that is going to be a choice now for a lot of these countries, developing countries, saying: Well, look what happened in that crisis. Those that limited their exposure were better off.
Is there some risk of this, do you think, of happening?
And a follow-up on that one would be the issue of green shoots. Larry Summers, I think, coined that phrase. I’m not sure if it’s a different phrase. But have you seen in previous recessions that are attached financial crisis where there have been signs of green shoots that have then died and then emerged again?
MR. BLANCHARD: One question is to Stephan. Maybe on the other one, Marco can say something.
MR. DANNINGER: I think what the current crisis just brings out very clearly and to answer your question affirmative is that there are risks associated with financial integration, but international financial integration is not a byproduct. It’s actually very much an ingredient for growth and acceleration, especially in terms of catching up or moving towards advanced economy levels of income for emerging economies.
So you have on the one side this, I think, very important and continuing process of financial integration, but, as this crisis manifests, it’s associated with risks. And the policies and frameworks that should be in place for countries that have or did not have any homegrown vulnerabilities should be a system of protection at hand that provides them some buffer if the crisis hits.
I think one of the initiatives at the Fund, the flexible credit line, is one of these arrangements that would help countries weather these storms.
MR. TERRONES: Regarding to the green shoots, I don’t recall of countries going with these deep recessions. I don’t recall.
MR. MURRAY: Okay. I think we’re going to wrap this up now. Again, thank you for coming.
We have about roughly an hour to go before the embargo on this briefing and the contents of the documents expires. Again, that’s 10:30 a.m. Washington time, 14:30 GMT.
Next week, April 22nd, here at IMF Headquarters, Mr. Blanchard and the Research Department will be briefing on the World Economic Outlook forecasts. That’s Chapters 1 and 2. We look forward to seeing you then.
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