what caused the global financial crisis??€¦ · financial crisis? ouarda merrouche (wb) and...
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What Caused the Global Financial Crisis?
Ouarda Merrouche (WB) and Erlend Nier (IMF)
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Contribution • We document how ample liquidity ahead of the
crisis encouraged increases in leverage sourced in wholesale funding markets. – for OECD countries over 1999-2007
• We provide evidence on the ultimate drivers of the build-up – Was it monetary policy (low short rates)? – Was it global imbalances (capital flows)? – Did differences in the supervisory regime matter?
• We investigate whether monetary policy affected the direction of capital flows.
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Key findings • Capital flows rather than low policy rates were the key
driver of increases in leverage sourced in wholesale markets. – Capital flows reduced the spread between long and short rates,
causing banks to “lever up”. – The effect of capital flows on financial imbalances is less
pronounced where the supervisory environment was strong. • Main findings carry through to alternative measures of
financial imbalances – e.g. credit to GDP, household indebtedness to GDP; and house
prices. • Monetary policy had an effect on the direction of capital
flows – Capital inflows are higher where policy rates were high relative
to global rates (especially in smaller advanced economies).
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Outcome: ratio of bank credit to deposits
• Captures at country-level the build-up of leverage through expanded wholesale funding. – Turned into Achilles heel of the system when
wholesale funding dried up from August 2007 (Oct 2008)
• Robust predictor of distress at banking firms since August 2007 (Huang and Ratnovski, IMF)
• Correlates strongly with ex post financial sector support at the country level (47 % at 5 per cent significance)
– Increased ahead of global crisis and ahead of other regional crises (Nordic and Asian crises).
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1.1
1.2
1.3
1.4
1.5
Ave
rage
Ban
k C
redi
t/Dep
osits
ratio
1998 2000 2002 2004 2006 2008Year
Average ratio of credit to deposits across OECD countries 1999-2007
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Empirical approach
• For OECD countries, 1999-2007, regress outcome variable (credit to deposits) on – monetary policy stance (deviation from Taylor rule) – capital flows
• current account • long-term short-term spread
– supervisory variables – year-fixed and country-fixed effects, where possible
• Use interactions between macro-and supervisory variables to strengthen causal interpretation.
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Interactions
8/15/2012 7
MACRO
Global imbalances
Low short rates
FINANCIAL SECTOR
Inadequate
Supervision
and Regulation
Excessive leverage and
risk taking
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Supervision and regulation
• Central bank supervision • May lead to tougher supervision, e.g. of liquidity
• Supervisory and resolution powers • May reduce moral hazard
• Restrictions on activities • Can facilitate supervisory monitoring and reduce moral
hazard
• Entry barriers • Can lower competition and reduce risk taking
• Capital regulation stringency • Can increase resilience to shocks but may also constrain
credit
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Main results
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Macroeconomic drivers of leverage (credit to deposits) 1999-2007
(1) (2) (3) (4)
Current account %GDP -0.029** -0.029*
Deviation of policy rate from Taylor rule 0.018 -0.006
Long-term-short term spread -0.063* -0.056**
Country FE x x x xYear FE x x
Observations 196 196 196 196Number of countries 22 22 22 22R-squared 0.25 0.19 0.08 0.03Robust standard errors clustered by country in brackets* significant at 10%; ** significant at 5%; *** significant at 1%
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Countries' regulatory and supervisory framework
(1) (2) (3) (4) (5) (6)
Current account %GDP -0.027** -0.025* -0.026* -0.026* -0.026* -0.026**
Deviation of policy rate from Taylor rule 0.018 0.018 0.018 0.018 0.018 0.018
Central bank supervision index -0.159 -0.195*
Supervisor power index -0.068** -0.080***
Banking sector activity restriction index 0.058 0.047
Banking sector entry barriers index -0.038*** -0.049
Capital regulation stringency index -0.014 0.074
Constant 1.615*** 2.341*** 1.027* 1.896*** 1.578*** 2.329***
Year FE x x x x x x Observations 196 196 196 196 196 196 Number of countries 22 22 22 22 22 22 R-squared 0.25 0.25 0.25 0.25 0.25 0.25 Robust standard errors in brackets * significant at 10%; ** significant at 5%; *** significant at 1%
Drivers of Leverage in the Banking Sector 1999-2007
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Macro and supervisory variables - interaction effects
12
(1) (2) (3)
current accountLong-term short
term spreadMonetary policy
stance
Current account %GDP -0.124** -0.026**
Deviation of policy rate from Taylor rule 0.024 -0.07
Long term-short term spread -0.380**
Macro-Factor*Central bank supervision 0.012* 0.040*** 0.009
Macro-Factor*Supervisor power 0.002** 0.008*** 0.014*
Macro-Factor*Activity restriction -0.002 0.007 -0.006
Macro-Factor*Entry barriers 0.016*** 0.014* -0.001
Macro-Factor*Capital regulation -0.012 -0.003 -0.006
Year FE x x xCountry FE x x xObservations 196 196 196Number of countries 22 22 22R-squared 0.34 0.23 0.29Robust standard errors in brackets* significant at 10%; ** significant at 5%; *** significant at 1%
Macro-Factors
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Robustness
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Alternative outcome variables
(1) (2) (3) (4) (5) (6) (7) (8)
Current account %GDP -0.038** -0.038** -0.031** -0.031** -0.013** -0.012** -2.242** -2.199**
Deviation of monetary policy from Taylor rule 0.008 0.000 0.024 0.021 0.008 0.010 0.218 -1.111
Real GDP growth rate -0.03 0.02 -0.008 -4.364*
Inflation rate -0.014 -0.011 -0.002 -2.685
Country FE x x x x x x x xYear FE x x x x x x x xObservations 184 182 192 190 187 186 162 161Number of countries 21 21 22 22 21 21 18 18R-squared 0.45 0.44 0.25 0.24 0.73 0.73 0.73 0.73Robust standard errors in brackets* significant at 10%; ** significant at 5%; *** significant at 1%
Credit/GDPFinancial sector credit/deposits
Household debt/GDP House price index
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Robustness • Alternative outcomes
• Alternative measures of monetary stance – e.g., prolonged deviations from Taylor
• All variables lagged (endogeneity)
• Alternative samples – euro area only; OECD excluding U.S.
– boom period, 2003-2007
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Extension
Drivers of “global imbalances”
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Determinants of the current account (capital flows)
Small countries Large countries(1) (2) (3)
Government budget surplus %GDP 0.233 0.313 -0.087
Openess ([Exports+Imports]/GDP) 0.044 0.063 0.043
Private savings rate 0.262*** 0.166 0.471**
Output growth -0.18 -0.813 1.426**
Domestic-USA spread -0.796** -1.416*** 0.23[0.305] [0.259] [0.313]
Country FE x x xYear FE x x x
Number of observations 191 95 96Number of countries 22 11 11R-squared 0.33 0.44 0.34Robust standard errors in brackets* significant at 10%; ** significant at 5%; *** significant at 1%
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Implications for macroprudential policy
• Monetary “leaning” is second-best and can be counterproductive (esp. in small countries)
• Macroprudential policies need to address vulnerabilities from capital inflows – countercyclical capital, charges on liquidity risks
• Also review: – role of central banks in regulation – supervisory and resolution powers – entry barriers (competition)
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Credit to deposits around crises events
Asian crisis
Nordic crisis
.81
1.2
1.4
Ban
k cr
edit/
bank
dep
osits
-10 -8 -6 -4 -2 0 2 4 6
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Correlation between leverage and house price increase
20
AUSBE
CA
DE
DK
FI
FR
IR
IT
JP
NE
NONZSP SWE
SWI
UK
US
-50
050
100
% V
aria
tion
in H
ouse
Pric
es
0 1 2 3 4Bank credit/Bank deposit 2007
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Correlation between leverage and Support to the financial sector
21
AUS
AUBE
CAFR
DEGR
IR
IT
JP
NE
NO
POSP
SWE
SWI
UK
US
050
100
150
200
Tota
l sup
port
as %
of G
DP
0 1 2 3 4Bank credit/Bank deposit 2007
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-1.5
-1-.5
0.5
Ave
rage
OE
CD
dev
iatio
n of
pol
icy
rate
from
Tay
lor r
ule
1998 2000 2002 2004 2006 2008Year
Average OECD country monetary policy stance 1999-2007
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Average long-term short-term spread, OECD countries 1999-2007
-.5
0.5
11.
52
Ave
rage
long
-term
sho
rt-te
rm s
prea
d O
EC
D c
ount
ries
1998 2000 2002 2004 2006 2008Year
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Cross-sectional variation of current account imbalances
56
78
910
Stan
dard
dev
iatio
n of
cur
rent
acc
ount
bal
ance
s as
% G
DP
1998 2000 2002 2004 2006 2008Year