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Economy & markets after the financial crisis What have we learned and where are we heading? Economics, UiO, March 7 2011 . Harald Magnus Andreassen Today. On markets and our ability for forecast the future ’After’ the Financial Crisis What happened, and why? The world economy

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Economy & markets after the financial crisis What have we learned and where are we heading? Economics, UiO, March 7 2011

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Economy & marketsafter the financial crisisWhat have we learned and where are we heading?Economics, UiO, March 7 2011

Harald Magnus Andreassen


  • On markets and our ability for forecast the future

  • ’After’ the Financial Crisis

    • What happened, and why?

    • The world economy

    • The Norwegian economy

  • What have we learned?

    • Implications for monetary, fiscal & regulatory policy

Some good advices

  • Read history

  • Read economic & financial history

  • Read history on economic theories

  • Never forget that economics is a social science

    • With no eternal truths

    • Do never underestimate the importance of (changing) institutions, created by human beings

  • Do not trust old truths nor old people, and even less new truths – and certainly not mine

First Securities ASA

  • Brokerage/investment bank/merchant bank

    • Equities, corporate

    • Merchant bank – with Swedbank, trading all sorts of int. rate/fixed income instruments, Private Bank, Investment Management +++

    • 240 employees

    • 25 analysts (the best &…)

    • 7- 8% + of revenues on the Oslo Stock Exchange

  • We are better bean counters, than dreamers

  • We give goods advices

  • Our clients appreciate us

  • We hire business school graduates all the time, and economists from time to time. Our trainee-program works!

The real proof of the pudding:

This should not have been possible!

Long term: Real fundamentals decide

A Tobins q, calculated from the balance sheet

Still: A big swinger

A quite close connection

The stock market vs. actual earnings… Sic!

Take care, when you buy

Forward looking equity analysts?

.. But are economists any better?

Forward or backward looking?

For investors: The long end vs. the short end

Long term interest rates decided by today’s fundamentals

What am I looking at?

  • Demand cycles (”Keynes”) – debt cycles (“Minsky”)

    • C, I, G-T, X-M

  • Supply cycles (Real business cycles)

  • What’s most important?

    • Markets are mostly “Keynesian” (animal spirit, risk appetite, financial condition, monetary/fiscal policy impulses/responses)

    • Late follower of fashion? Or realistic, what works?

The financial crisis

Crisis, what crisis? It’s (still) a real one!

  • The hardest downturn in the world economy since ’45

  • Millions of families are forced out of their homes

    • 1 out of 7 US mortgages in delinquency. New foreclosures 1:20, annual rate!

    • Unemployment sharply up almost everywhere

  • The banking system had to be guaranteed by the governments, more than ever

  • Zero Interest Rate Policy everywhere, for the first time

  • An unprecedentedfiscal stimulus, almost everywhere, record high deficits & high and rapid rising debt ratios

  • Will (some parts) of the system be changed? You bet..

What it is all about

Why did it happen?

  • Bad policy

  • Bad banking

  • Bad luck

Why did it happen?

  • A deregulated financial sector exploited too many new ways to boost profits, as always. The capital base eroded

  • Central banks looked another way and kept rates too low for too long

  • Many regulators did not understand what was going on, and others did not have the mandate to prop the party

  • The borrowers did not understand anything

  • The rating agencies did not see anything before it was too late

  • Asia and Opec saved more than others and could afford to borrow

  • A global, integrated financial system

This was a bubble

It was not totally invisible!

And many warned: OECD, IMF, Shiller, BIS…

Tobin’s q (or P/B) works! An investment boom

More liquidity in the system

IMF: Housing busts not uncommon – but expesive

Banking crises: It’s not the first time

Many more now

28 y, 17 countr.113 ”crises”

A banking crises every 10th year

We do not need CDOs and structured products. Just human beings

Does ’our’ model work? Well..

Banking crises and capital mobility

Rogoff & Reinhart


What have we learned?

  • That we have not learned too much..

  • From time to time: We start dreaming…

    • .. At least not in finance, and we got the money

    • Markets do not always work as described in many textbooks

      • But many theories are based on situations where markets do not solve all problems: Keynes, Minsky, Shiller, Tversky, Kahneman, Kindleberger +++

  • Banks are not as other businesses

    • And must be regulated in another ways

  • Monetary policy is more than inflation targeting

What did we already know?

  • “Over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money” – Irving Fisher (1933)

These crazy Americans

Long-term risk: Imbalances in the household sector

China is responsible?

Current accounts, USD 1997 and 2008

The financial crisis

The economy

The fiscal response

After financial crises:

  • Debt ratios back to where they came from (takes 5 – 10 y)

  • Slower growth than before the crisis

    • But usually not ’double dips’

  • A lower activity level, higher unemployment

  • Property prices back to where they came from

  • Private deficits and debt transferred to the public sector

Something hit us…

What goes up, must come down. Credit/GDP

Reinhart & Reinhart

This time is probably not different

Reinhart & Reinhart

What’s driving the cycle?

1 Bad times

2 Soft landing

3 ’Happy’ days

An unprecedented increase in private savings

The flip side of the coin: An unprecedented increase in public sector deficit – because the current account is quite stable short to medium term for rich countries in aggregate

Once upon the time – in 2007

And today!

Can you find the two outliers?

This is not sustainable

But the problems are not the same everywhere

Public debt: Most are on the wrong side of the curve

Maastricht criteria

Still: Debt is not out of control yet (everywhere…)

Some has a job to do

Some have done it before

Initial fiscal position vs. adjustment

Adjustment % of GDP

Underlying budget balance before consolidation

OECD, 2010

85 episodes, 24 countries sice 1978. No one defaulted

Still, quite worrying

A Greek debt restructuring not unlikely

Irland is now asking for lower interst rates on EMU loans

It has happened before

Rogoff, Reinhart

Usually following banking crises

Public finances - outlook

  • Default is not an easy way out

  • Some countries must cut now, whatever cost

    • They have been living beyond their means far too long, huge current deficits the real problem

    • Most cuts are sensible, long term

  • Others must cut too, but not much now

    • Impossible to cut deficits substantially before private savings fall

    • In addition: Most of the increase in deficits is due to automatic stabilisers

  • What has surprised us over the past year?

    • Greece & co was willing and able to cut

    • Germany & co was willing to ‘help’ struggling neighbours

The financial crisis

The way out

Why quite optimistic?

  • EM was not and is not a bubble – but inflation is increasing

  • Households and the corporate sector are saving more and are consolidating faster than ever before

    • Most bubbles have already burst

  • Credit markets are in better shape, as are many banks

    • Total borrowing cost is normal to extremely low. Volumes high

  • Short term interest rates will remain low, long term rates are low (QE)

  • No aggressive fiscal tightening in most countries, for now

  • Deficit & debt problems in the European PIGS is most likely containable – but the risk is still high

The financial crises is over

On the way back

Emerging Asia in the lead

Business surveys are very strong again

One day, enough is enough

Cash flows are strengthening sharply!Funding is more available. Plans are revised upwards

Employment vs. productivity & profits

US: Employment will come back quickly – profits less so

Europe: Profits will come back quickly – employment not

Inflation now??

Ing. Phillips still on duty

As in Europe

Norway: U at 3.5% is sufficient to get wage inflation down

Higher wage inflation some places

The financial crisis

A Norwegian exceptionalism?

A small open economy (you might think)

Norway was not hit too hard

The labour market confirms the difference

Something has happened here too

Savings up to record high levels

We had our own credit boom!

It did not end up in a credit crisis, this time

Where did the ’financial crisis’ take place?

Noway vs. Sweden. Different, but not due to what you thaught

Who’s footing the bill?

Why has Norway managed so ’well’?

  • Not much due to oil investments

  • Not much due fiscal policy (it was like in other countries)

  • Not due monetary policy (it was like in other countries)

  • Not much due to a smaller fall in Mainland domestic demand than among others

  • But because we (net) exported us out of it!

  • .. And the employers picked up much of the bill

Norway is speeding up agian

On the way up agian

This time is different! Or not??

So what?

Monetary policy: Inflation targeting or something more?

  • Inflation targeting had achieved academic and practical hegemony

  • Flexible inflation targeting – rates set to reach the inflation target medium term

    • Inflation forecasts, interest rates paths – anchoring expectations

    • Will usually try to stabilise the real economy

  • Asset prices, debt important only if inflation is influenced within the normal planning horizon

  • Asymmetric response: Let asset prices/debt climb. Clean up the mess afterwards, if necessary

The original position on montetary policy

  • We can not know for sure that it is a bubble

    • Or ”Bubbles can not exist”

  • We can not do anything about it or we will create an economic downturn if we try

  • It’s better to clean up afterwards, if it is a bubble and in burst

  • We take asset prices, debt into account

What’s left?


  • We can not know for sure that it is a bubble

    • Or ”Bubbles can not exist”

  • We can not do anything about it or we will create an economic downturn if we try

  • It’s better to clean up afterwards, if it is a bubble and in burst

  • We take asset prices, debt into account



The obvious answers – put the blame on the others

And it is not totally unfair

  • Bank capital ratio requirements were too low – and they are now raised everywhere

  • Regulations must be followed up

  • A new capital regime is now underway (BIS, Basel etc.)

    • Higher and flexible capital requirements

    • New thinking on X-country banking vs. regulations and deposit insurance

    • ..And even on capital mobility

Still, something more??

  • What if asset prices & debt are the most important transmission mechanisms between monetary policy & CPI inflation? They are..

    • Huge asset price/debt expansions are very often followed by economic crises

    • Many have argued that longer term stability concerns may justify a tougher ‘leaning against’ strategy – even if inflation becomes too low for a while

    • Does the asymmetric response create moral hazard?

  • And what if the exchange rate is an important channel?

The road ahead

  • Financial stability is extremely important

  • The DSGE-paradigm/models are not suited to understand important elements of the economic reality

    • Unrealistic assumptions on behaviour, not empirically based

    • The financial sector is not explicit modelled

  • We must learn more about the banking sector

    • They are the engine in the boom/bust economy (Tobias Adrian, Shin)

    • Monetary policy can influence the banks’ risk willingness/risk exposure

  • Monetary policy is far more the massaging inflation- and interest rate expectations

    • And if CBs succeed, they will create unrealistic assessment of risk

The German tradition

Can any central bank rely solely on developments in money and credit to come to its policy decisions? The answer is clearly “no”.

Can any central bank afford to ignore the information in monetary developments in formulating monetary policy? Again, the answer is “no”.

Otmar Issing, ECB, FT 15. des 2005

Norges Bank is becoming more flexible

  • The interest rate is set by the central bank to achieve an inflation rate of 2½ per cent in two years (The Bank’s interpretation of the mandate established in 2001)

  • In normal times the interest rate is set to achieve 2½ per cent inflation two years later (2002)

  • […] set the interest rate to achieve the inflation target within a reasonable time, normally within 1-3 years (2004)

  • […] choose an interest rate to stabilise the inflation close to the target within a medium horizon (2007)

  • […] we should probably apply a fairly long horizon for achieving the target so that we seek to take account of any imbalances that might disturb activity and inflation further ahead.(2009)

Monetary policy in a new world

Learn more about financial markets

Integrate financial stability into macro models/policy

Macroprudential measures

.. And a lot of lessons for the financial regulators!

"I can calculate the movement of the stars, but NOT the madness of men."- Sir Isaac Newton, after losing a fortune (£20,000) in the bubble

Norwegian interest rates

Growth vs interest rates

ECB vil sannsynligvis heve renten i aprilInternasjonale renteforventninger steg betydelig

Renteøkning i april er så godt som sikkert. Trichet brukte uttrykket ”strong vigliance” og sa at renteøkning i april er ”possible but not certain” (fordi ECB aldri binder seg på forhånd).

Høyere renter ute = høyere rente hjemmeUtenlandske FRA-renter opp inntil 100 bp siden oktober

Men NOK er sterk og vil bidra til lavere rentebane

Forrige uke: ECB dro EUR rett opp. USD sklir ned

Rentebanen blir oppjustert i mars, tross sterk kroneNy bane vil trolig inneholde renteheving i mai eller juni

Positivt: Renter ute, vekst og dermed økt inflasjon

Negativt: Sterk NOK og høyt kredittpåslag i NIBOR

Nok en gang snudde EURNOK på rundt 7.70

Global rates explains most of the variation in longer-term interest rates in Norway

Norwegian FX

Short term interest rates are important short term

How strong is the NOK vs EUR?

NOK TWI more than one stronger than historical average

NOK slightly stronger than assumed (import weighted exchange rate)

How strong is the NOK really?

A strong NOK because we have deserved it!

BEER model for NOK: Marginally overvalued

Stronger NOK

Short term model does not support a stronger NOK now

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