Fiscal and Financial Crises · – O\en occurred with the failure of an important ﬁnancial...

$: Fiscal and Financial Crises · – O\en occurred with the failure of an important ﬁnancial ins6tu6on • A banking panic, if not prevented by the MA, will lead to massive banking$
FiscalandFinancialCrises

MichaelBordoandChristopherM.Meissner

CzechNa6onalBank,PragueMarch212016

1

Introduc6on•  TherecentEurozonecrisisinvolvedbothsovereigndebtandthebankingsystem.

•  Debtcrisescombinedwithbankingcrisesarenotnew.

•  IntheEurozonecrisis,athreatenedGreekdefaultfedintoabankingcrisisbecauseEZbanksheldlargeamountsofsovereigndebt.

•  AguaranteeoftheIrishbanksin2008ledtoadebtcrisiswhichfedbackintothebanks.

2

Introduc6on

•  TheAsianCrisisof1997-98viaaguaranteeofbanksledtoatriplecrisis;debt,bankingandcurrency

•  Triplecrisesalsooccurredinthe1890s

•  Thepaperexaminestheinterconnec6onsbetweenfinancialandfiscalcrisesbasedonhistory,theory,andempirics.

3

HistoricalOverview•  FinancialCrisescanbetracedback100sofyears(Kindleberger

1987)

•  Thenatureandoriginsoffiscalcrisesandtheirrela6onshiptobankingcriseshaschangedoverthelong-run.

•  Bankingcrisesbeforedepositinsurancewerebankingpanics.

•  Panicswouldpropagatethroughassetmarketsviafiresales.

•  Bankingcrisescanoccurasaconsequenceofbankcreditdrivenassetpricebooms.

•  Bankingpanicscouldbecausedbyshockstoshadowbanks.

4

HistoricalOverview•  BankingCriseshaveo\enspreadtomanycountries.

•  Interestrateshocksinthefinancialcenterwaso\enthetrigger.

•  AdvancedcountrieshadmanypanicsinthenineteenthcenturybeforecentralbankslearnedtobeLLRs.

•  Withtheadventofdepositinsuranceandotherformsofguarantees,bankingpanicsbecamebankingcriseswhichwereresolvedbyafiscalrescue.

5

HistoricalOverview

•  Thiscreatedadirectlinkbetweenthebankingsystemandthegovernment’sbalancesheet.

•  Costlybailoutscouldleadtofiscalimbalancesand,possibly,defaults.

•  Guaranteescouldcreatemoralhazardwhichcouldleadtohigherbailoutcostsandriskoffiscalcrisis.

6

HistoricalOverview

•  Beforethe1930ssovereigndefaultshadbeenfrequent,especiallyinemergingcountries.

•  Theyreflectedcapitalflowbonanzas(ReinhartandRogoff2009)andsuddenstops.

•  Manyemergingcountrieswereserialdefaulters(Reinhart,Rogoff,Savastano2003).

7

HistoricalOverview•  CurrencyCriseswereafrequentoccurrenceofemerging

countriesthroughoutthenineteenthandtwen6ethcenturies.

•  Advancedcountriesfacedthemduringthe1930sandunderBreeonWoods.

•  Twinbankingandcurrencycriseshavealsooccurredsincethenineteenthcentury(KaminskyandReinhart1989).

•  Causalitywaso\entwoways.Akeyconduitwasforeigncurrencydenominateddebt(originalsin).

8

HistoricalOverview•  Originalsin(foreigncurrencydenominateddebt)linkedbanking,

currencyanddebtcrisestogetherinthe1890s(BordoandFlandreau2003).

•  Originalsincombinedwithgovernmentguaranteeslinkedthethreetypesofcrisestogetherinthe1990scrises.

•  TherecentEurozoneCrisiswastheculmina6onofalonghistoryofdifferenttypesofcrisesandtheirgrowinginterconnec6ons.

•  Theinterconnec6onsreflectedfinancialglobaliza6onandabeliefinthenecessityforgovernmenttosocializetheincomelossesoffinancialcrises.

9

3.FinancialandFiscalCrises:Theory

•  BankingCrises

•  Thetradi6onalviewofabankingcrisiswasabankingpanicorliquiditycrisis.

•  Itoccurredinacontagiousbankingwhenthepublicfearfulthattheirbankswillnotbeabletoconverttheirdepositsintocurrencyaeemptsenmasstodoso.

10

BankingCrises•  UnlessallayedbyaLLRtherealeconomywillbeimpactedbya

declineinmoneysupply,impairmentofthepaymentsystemandinterrup6onofbanklending.

•  PostWWIIwithdevelopmentofasafetynetbankingpanicshavebecomerare.

•  Insteadbankingcrisesinvolvetheinsolvencyofthebankingsystem.

•  Unlikepanicswhicharebriefepisodesresolvedbythecentralbank.

•  Abankingcrisisisaprolongeddisturbancethatisresolvedbythefiscalauthori6es.

11

BankingCrises:Tradi6onalapproaches

•  Monetaristapproach–  FriedmanandSchwartz(1963)bankingpanicsareimportantbecause

oftheireffectsonmoneysupplyandhencerealincome

–  Bankingpanicsoccurbecauseofalossofconfidenceinthebanksintheirabilitytoconvertdepositsintocurrency

–  O\enoccurredwiththefailureofanimportantfinancialins6tu6on•  Abankingpanic,ifnotpreventedbytheMA,willleadtomassive

bankingfailuresofotherwisesoundbanksforcedintoinsolvencybyafallinthevalueoftheirassets

•  BankingPanics1930-33reducedMbytheMmul6plierandreducedrealincome

12

BankingCrises:Tradi6onalApproach

•  Debateoverwhetherbankingcrisesofthe1930swerereallyliquiditypanicsorreflectedbankinsolvencyasendogenousresponsetorecession.

13

BankingCrises:FinancialFragilityApproach

•  Minsky,Kindleberger,Fisher(1933)sawfinancialcrisesasanecessaryconsequenceoftheexcessesofpreviousboom.

•  AccordingtoFisheranexogenousdisplacementini6atestheupswinginthecycle

•  Thisleadstocreditfinancedinvestmentboom

•  Theprocesscon6nuesun6lastateofoverindebtednessisreached

•  Acrisiscanbetriggeredbyerrorsinjudgement—aMinskymoment

•  Distressedsellingleadstodeclinesinassetpricesandthepricelevel

14

BankingCrises:FinancialFragility

•  Fallingpricesleadtodebtdefla6on…

•  IntheCrisisof2007-2008theLehmanfailureviewedasaMinskymoment.

•  BISviewfollowsthisapproach–keyroleforthecreditcycleingenera6ngcreditdrivenassetpriceboombustsandfinancialcrises.

15

BankingCrises:BusinessCycleApproach

•  Depositorsan6cipa6nganincreaseinnonperformingloansduringarecessionwilltrytoprotecttheirwealthbywithdrawingtheirdepositsprecipita6ngabankrun(Mitchell1941,AllenandGale2007).

•  Gorton(1988):depositorsan6cipa6ngadeclineinincomeinanaeempttosmoothconsump6onremovefundsfrombanksbeforethebusinesscyclepeak.

16

BankingCrises:Recentapproaches

•  DiamondandDybvig(1983)– banksintermediatebetweendemanddepositsandlongterminvestments

–  Possibilityofmaturitymismatch– Aruncanbetriggeredbyasunspotbecausera6onaldepositors,notwishingtobelastinlinerushtoconvertdepositsintocurrency

•  ApaniccanbepreventedbyDIorLLR

17

BankingCrises:RecentApproaches

•  ExtensiveliteraturebasedonDD(1983)

•  DD(1983)extendedtoincludefinancialmarkets(AllenandGale1998);bubbles,monetarypolicy(DiamondandRajan2001…),interbankmarkets(Bhaeacharyaandgale(1987);LLR(HolmstromandTirole(1998)

18

BankingCrises:Informa6onAsymmetry

•  Depositorscannotcostlesslyvalueindividualbankassetsandhencehavedifficultymonitoringbankperformance(JacklinandBhaeacharya1988)

•  Apanicisaformofmonitoring

•  Facedwithnewinforma6onwhichraisestheperceivedriskinessofbankassets,depositorsforceoutbothsoundandunsoundbanksbyasystemwidepanic

19

FiscalCrises

•  DebtCrises

– Adebtcrisisariseswhenfiscalauthori6esareunabletoraisesufficienttaxrevenueinthepresentandthefuturetoserviceandamor6zedebt

– AdebtcrisiscanbecomeabankingcrisiswhenitimpingesonthebankingsystemandacurrencycriseswhenitthreatensCBreserves

20

FiscalCrises

•  Bankingcrisescanfeedintodebtcriseswhenthefiscalauthori6esbailoutinsolventbankswhichthenincreasessovereigndebtun6litbecomesunsustainable.

•  DebtCrisescanspillintobankingcriseswhenbanksholdsovereigndebt

21

DebtCrises:Theory•  EatonandGersovitz(1981).Fearoflossofaccesstocreditmarketsprevents

debtorsfromdefaul6ng

•  BulowandRogoff(1989).Fearofsanc6onsexplainswhycountriesavoiddefault

•  Debateoversanc6ons(ColeandKehoe,Eaton1996,KletzerandWright2000)

•  Serialdefault(Reinhart,RogoffandSavastano(2003)persistenceindefaults•  Countrieswhichwereserialdefaultershaddebtintolerance

•  ReinhartandRogoff(2009)dis6nc6onbetweendomes6cdebtandforeigndebt

22

FiscalCrisesandFinancialCrises•  Akeyintegra6ngelementbetweenfinancialandfiscal

crisesinthepostWWIIerawasthewidespreadusebythegovernmentofguaranteesoftheliabili6esofthebankingsystem.

•  Seminalar6clebyDiazAlejandro(1985).

•  DescribesChileanliberaliza6onofdomes6cfinancialsystemandcapitalaccountinlate1970s.

•  Thisledtoheavycapitalinflowswhichledtoincreasesinbankcreditandcreatedanassetpriceboom.

23

FiscalCrisesandFinancialCrises•  AmajorChileanbankfailurein1977ledtoagovernmentbailout.

•  Thisencouragedmoralhazard

•  In1982morebanksfailedandtheirliabili6esguaranteed

•  Thismeantthatthegovernmenthadtakenonanewcon6ngentclaimwhichledtoagrowingfiscaldeficit

•  TheCBfinancedthedeficitbyprin6ngmoneythisledtoaspecula6veaeackontheCBsreserves

•  Amajorbankingandcurrencycrisisensuedinsummer1982followedbyadebtcrisisin1983.

•  McKinnonandPill(1986)tellasimilarstory

24

FiscalCrisesandFinancialCrises•  TheJapanesebankingcrisisin1990wasprecededbyarealestate

andstockmarketboom,fueledbybanklendingandloosemonetarypolicy.

•  TheBOJfollowedloosemonetarypolicya\erthePlazaAccordof1985.

•  ThebustwastriggeredbyBOJ6ghteningtostemtheassetpriceboom.

•  Thecollapseinassetpricescreatedbankinsolvency.

•  ThebailoutcostsofthebankrescueincreasedtheDebt-to-GDPra6o,butJapandidnotdefault.

25

FiscalCrisesandFinancialCrises•  TheNordicfinancialcrisisof1991-1992involvedabankingcrisis,currencycrisisandlargefiscalbailouts

•  Liberaliza6onofthefinancialsectorandcapitalaccountinthe1980sledtoabankcreditfueledassetpriceboom.

•  TheEMScrisistriggeredthebustandcrises.

•  LoanlossesinNorway,SwedenandFinlandwerehigh,butthefiscalresolu6onsdidnottriggerafiscalcrisis.

26

FiscalCrisesandFinancialCrises•  TheAsianCrisisof1997-98involvedbanking,currencyanddebtcrises

•  Thecriseswereconnectedbygovernmentguaranteesandoriginalsin.

•  TheAsianTigersborrowedabroadextensivelyinforeigncurrency.

•  Theriskwithoriginalsinisthatifthecountryhasacurrencycrisisanddevaluesitscurrencyitwillhavetogenerategreatertaxrevenuesindomes6ccurrencytoserviceitsforeigndebt.

•  Thisdepressestherealeconomyandincreasesthelikelihoodofaforeigndefault.

•  Alsobanksfundedtheirloanswithforeignsecuri6eshencea\erdevalua6ontheycouldbecomeinsolvent.

27

FiscalCrisesandFinancialCrises•  TheAsianCrisisledtoThirdGenera6onspecula6veaeackmodels.

•  AccordingtoKrugman(1998),theAsianbanksengagedinriskylendingontheassump6ontheywouldbebailedout.

•  Theloanswerefinancedabroadinforeigncurrency

•  Thecapitalinflowandbankcreditboomfinancedanassetboom,overinvestmentandacurrentaccountdeficit.

•  Adevalua6onledtoafinancialcrisisbecausethebankswithforeignliabili6esbecameinsolvent.

•  Dooley(2000)tellsasimilarstory.Heemphasizedtheliabili6esofthemonetaryauthori6esbackingthesafetynetasanalterna6veclaimantontheCBsinterna6onalreserves.

28

FiscalCrisesandFinancialCrises•  Burnside,EichenbaumandRebelo(2004)emphasizetheroleofgovernmentguarantees.

•  Whenadevalua6onoccursthebanksdefaultontheirforeigndebtbutthegovernmentdoesn’thavetheresourcestopayforthebailout.

•  ThiscanleadtoacurrencycrisesiftheMAprintsmoneyorafiscalcrisis.

•  Corsen,Pesen6andRoubini(1999)tellasimilarstory.

29

FiscalCrisesandFinancialCrises•  TheEurozoneCrisis2010-2014

–  ReinhartandRogoffprovidecomprehensiveevidenceonthelinkbetweenbankingandfiscalcrises

–  Theyshowthatbankingcriseso\enprecededebtcrisesandthatthedebttoGDPra6oby86%inthe3yearsfollowingabankingcrisis

–  Thisleadstoadowngradingofcreditra6ngandpossibledefault

–  TheEZcrisisseemstofitthepaeernwell

30

FiscalandFinancialCrises•  Duringthe2007-2008crisismanyEuropeancountriesengagedin

expensivebondfinancedbankbailoutswhichincreasedthefiscaldeficit.

•  EgIrelandwhichinSeptember2008guaranteeditswholefinancialsystem.

•  Deficitsalsoincreasedbecauseofexpansionarygovernmentexpenditureandreducedtaxrevenues.

•  AgainstthisbackgroundtheGreekgovernmentannouncementthatithadfalsifieditsbookssetthestagefortheEZdebtcrisis.

•  ThethreatenedsovereigndefaultbyGreecefedintoabankingcrisis,

becausebanksinGreeceandotherfinanciallyintegratedEZcountriesheldlargeamountsofGreekandotherperipheralEZsovereigndebt.

31

FiscalandFinancialCrises

•  BoltonandJeanne(2011)modeltheinterconnec6onbetweensovereignriskandthebankingsysteminacurrencyunionwherebanksholdothercountriessovereigndebt.

– Governmentbondsservesassafecollateralandallowsbankstoincreaseleverage.

–  Butthedefaultbyonememberspreadstotheothersviatheweakeningofbankporpolios.

32

FiscalandFinancialCrises•  Gennaioli,Mar6nandRossi(2014)modeltheinterconnec6onbetween

sovereigndefaultandthebankingsystem.

•  Banksholdsovereigndebtascollateral.Adebtcrisisleadstoacreditcrunchandafallinrealincome.

•  Acharya,DrechslerandSchnabl(2013)modelatwowayconnec6onbetweenfiscalcrisesandbankingcrises.

•  Bankbailoutsleadtoanincreaseinsovereignrisk.Thisweakensthebankingsystem.

•  EmpiricalevidenceonthespreadsbetweenbankCDSandSovereignCDSshowshowtheIrishbailoutledtothetransferofriskfromthebankstotothegovernment.

33

FiscalandFinancialCrises•  ModiandSandri(2012)showhowa\ertheBearStearns

bailoutinMarch2008spreadsincreasedincountrieswhichhadvulnerablefinancialsectorslikelytobebailedout.

•  A\erLehmanfailedinSeptember2008spreadsincreaseddrama6callyincountrieswithhigherdebtra6os.

•  Thena\erthefailureofAngloIrishbankinJanuary2009spreadsincreasedacrosstheEZreflec6ngtheincreasedvulnerabilityofthefinancialsystemsofallthemembercountries.

34

EMPIRICSOFFINANCIALCRISESOVERTHELONG-RUN

Sec6onII

35

DatasetsforFinancialCrises•  Long-RunData

–  Bordo,Eichengreen,Klingebiel,Marqnez-Peria(BEKM),1880-1997,21/55countries:banking,currencyandtwincrises

–  Reinhart&Rogoff,mainlypost-1800withanincreasingsamplesize.70countriesinthe20thcentury:banking,currencyanddebtcrises

–  Jordà,SchularickandTaylor(2011),17countries,1870-2011:bankingcrises

•  RecentData–  LaevenandValencia(2013),162countries,1970-2012:banking,currencyand

debtcrises

•  Da6ngoffinancialcrises:leadingauthorsdisagreeonthedefini6onofacrisisleadingtodifferentconclusionsabouttheimpactandcausesofcrises.

36

•  Table1showsdefini6onsforda6ngvarioustypesofcrises.

•  Thereisconsiderabledisagreementonthedefini6ons:e.g.forbankingcrises,authorsdisagreeabouthowmanybanksmustbeclosedorwhatsystem’scapitalmustbeimpairedforacrisistobeclassifiedassystemic.

37

Crisesdefini6ons

FinancialCrises:theHistoricalRecord

•  Wecompareoutcomesforvariouschronologiesandacrossfour6meperiods

•  Theclassicalgoldstandard(1880-1913);theinterwarperiod(1919-39);BreeonWoods(1945-1972);therecentperiodofglobaliza6on(1973tothepresent)

•  Weshowthesampleprobabili6esofexperiencingafinancialcrisis

•  Itiscalculatedasthera6oofthenumberofyearsinwhichthesetofcountriesinthesampleisinthefirstyearofacrisistothetotalnumberofcountryyears

40

41

Figure1showsthesamplepercentageofcountry-yearobserva6onsforthefirstyearoffourdifferenttypesoffinancialcrises.

Figure 1c Twin Crisis Frequencies Three Datasets, 1880-2012 Figure 1d Triple Crisis Frequencies, Four Datasets, 1880-2012

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

1880-1913 1919-1939 1945-1972 1973-

Twin

Cris

is Fr

eque

ncy

(ann

ual %

pro

babi

lity)

Bordo et. al Reinhart & Rogoff Laeven & Valencia

Figure 1a Banking Crisis Frequencies 1880-2012 Figure 1b Currency Crisis Frequencies. 1880-2009

0

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

1880-1913 1919-1939 1945-1972 1973-

Bank

ing

Cri

sis F

requ

ency

(ann

ual %

pro

babi

lity)

Bordo et. Al.(21 & 55 Ctrs.) Reinhart & Rogoff (70 countries) Laeven & Valencia (161 ctrs. 1973-2011) Taylor (17 countries)

0

0.01

0.02

0.03

0.04

0.05

0.06

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1880-1913 1919-1939 1945-1972 1973-

Cur

renc

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risis

Fre

quen

cy (a

nnua

l % p

roba

bilit

y)

Bordo et. al Reinhart and Rogoff Laeven & Valencia

Crisisfrequencies

•  Currencycrisesarethemostfrequenttypeofcrisesfollowedbybankingcrises,debtcrises,twincrisesandfinallytriplecrises

•  Thereissomecoincidenceinthedifferentdatasetsbetweenthefrequenciesoftypesofcrises

•  Figure1showsthatReinhartandRogoffandTaylordisplayahigherprobabilityofhavingabankingcrisisthanBordoetal.

•  ReinhartandRogoffshowthattriplecrisesarenowmorefrequentthanintheearlierperiods,incontrasttoBordoetalthattheyweremorelikelybeforeWWII.

42

43

Figure2showsthenumberofcrisesthatoccuraloneorconsideredwithothertypesofcrises.Asitcanbeseen,thecoincidenceofthethreetypesofcrisesismuchhighertodaythaninthepast.

44

Figure2(con6nued)

DisagreementandClassifica6onUncertainty

•  Intable2,wecompare4differentdatasets.•  Theaveragepercentageof6mesthatthecomparisonsagreeis0.43,excludingBreeonWoods,wheretheyallagree.•  Otherreasonsfordisagreementincludethedemarca6onoftwincrisesandconflic6nghistoricalsources.

45

46

PRE-WWI 1880-1913Bordo et. al. vs. RR

No crisis Banking Crisis same year +/-1 yearNo crisis 681 17 0.33 0.38Banking Crisis 5 1121 countries (21 in Bordo et. al. & 70 in Reinhart & Rogoff)

1880-1913RR vs. Taylor

No crisis Banking Crisis same year +/-1 yearNo crisis 533 16 0.36 0.55Banking Crisis 13 1617 countries (70 in Reinhart & Rogoff & 17 in Taylor)

1880-1913Bordo et. al. vs. Taylor

No crisis Banking Crisis same year +/-1 yearNo crisis 538 20 0.30 0.41Banking Crisis 8 1217 countries (21 in Bordo et. al. & 17 in Taylor)

Bordo et. al.

Bordo et. al.

Taylor

Reinhart & Rogoff

% agree

% agree

Taylor % agree

Reinhart & Rogoff

INTERWAR 1919-1939Bordo et. al. vs. RR

No crisis Banking Crisis same year +/-1 yearNo crisis 409 14 0.31 0.34Banking Crisis 8 10


No crisis Banking Crisis same year +/- 1 yearNo crisis 321 2 0.69 0.74Banking Crisis 9 2517 countries (17 in Taylor & 70 in Reinhart & Rogoff)


No crisis Banking Crisis same year +/- 1 yearNo crisis 323 5 0.65 0.87Banking Crisis 7 2217 countries (21 in Bordo et. al. & 17 in Taylor)

Bordo et. al.

Bordo et. al.

Reinhart & Rogoff

Taylor

Reinhart & Rogoff

Taylor

% agree

% agree

% agree

21 countries (21 in Bordo et. al. & 70 in Reinhart & Rogoff )

Table 2a Comparison of Leading Crisis Chronologies, 1880-1913 Table 2b Comparison of Leading Crisis Chronologies, 1919-1939

BRETTON 1950-1972WOODS Bordo et. al. vs. RR

No crisis Banking Crisis same year +/- 1 yearNo crisis 539 0 1.00 1.00Banking Crisis 0 0


No crisis Banking Crisis % Agree +/- 1 yearNo crisis 391 0 1.00 1.00Banking Crisis 0 017 countries (17 in Taylor & 70 in Reinhart & Rogoff)


No crisis Banking Crisis % Agree +/- 1 yearNo crisis 391 0 1.00 1.00Banking Crisis 0 017 countries (21 in Bordo et. al. & 17 in Taylor)

Bordo et. al.

Reinhart & Rogoff

Taylor


Taylor

Bordo et. al.

Reinhart & Rogoff

% agree

POST-BRETTON 1973-1997WOODS Bordo et. al. vs. RR



No crisis Banking Crisis same year +/- 1 yearNo crisis 614 6 0.59 0.70Banking Crisis 7 1917 countries (17 in Taylor & 70 in Reinhart & Rogoff)

1973-1997Bordo et. al. vs. LV


Bordo et. al.

Reinhart & Rogoff

55 countries (55 in Bordo et. al. & 162 in Laeven & Valencia)

Reinhart & Rogoff

Taylor


Bordo et. al.

% agree

% agree

% agreeLV

Table 2c Comparison of Leading Crisis Chronologies, 1950-1972 Table 2d Comparison of Leading Crisis Chronologies, 1973-2012

47

Table2(con6nued)1973-1997Bordo et. al. vs. Taylor

No crisis Banking Crisis same year +/- 1 yearBordo et. al. No crisis 407 6 0.39 0.39

Banking Crisis 5 717 countries (55 in Bordo et. al. & 17 in Taylor)

1973-2011RR vs. LV


1973-2010Taylor vs. LV

No crisis Banking Crisis same year +/- 1 yearNo crisis 618 3 0.54 0.59Banking Crisis 10 1517 countries (17 in Taylor & 162 in Laeven and Valencia)

Taylor

Reinhart & Rogoff

LV

Taylor

% agree

% agree

% agree

70 countries (70 in Reinhart & Rogoff & 162 in Laeven & Valencia)

LV

Table 2e Comparison of Leading Crisis Chronologies, 1973-2012 (cont.)

Notes to Tables 2a-2e: Tables present cross-tabulations of banking crisis indicators for each of four sources (Bordo et. al., Reinhart and Rogoff, Taylor and Laeven and Valencia) in four periods. We restrict attention to the first year of a banking crisis for a country. In each entry we show the number of non-crisis country-years, and the number of country-years with a crisis in either of two datasets for the countries that are common to both datasets. The entry in row 2 column 2 of each table records the number of times both datasets agree. The last two columns provide a measure of the agreement between sources calculated as the percentage of all crisis-years dated within the period and the country sample in which the two sources agree. We provide this percentage for crises occurring in the same year and then allow for a one year-window to allow for small variations in timing.

CausesofCrises

•  Followingtherecentcrisis,anewconsensusviewhasassignedaprimaryvaluetocreditboomsasthekeydeterminantandpredictoroffinancialcrises.

•  Butnotallthebankingcrisesaredrivenbycreditbooms.

•  Amoresa6sfactoryapproachtounderstandingthedriversoffinancialcrisesrecognizesthatthemicro-structureofthefinancialsystemmaeersaswellascredit.

48

CausesofCrises•  Thereareseveralapproachestounderstandingthecausesof

crises:1  Earlywarningindicators(KaminskyandReinhart(1999))–  Theycheckwhetheravariablesignaledabankingcrisiswithina12-

monthwindow.–  Theythenfindthresholdswherechanges/levelsofthevariable

minimizethenoise-to-signalra6o.–  Theyclassify16variablesasFinancialSector,ExternalSector,Real

SectorandFiscalSector.–  Thebestpredictorsforbankingcrisesare:apprecia6onofthereal

exchangerate,equitypriceboomandthemoneymul6plier.–  Recentresearch(Babeckýetal.(2014),Drehmanetal.(2012),

GourinchasandObspeld(2012))emphasizethefinancialcycle(domes6ccredit/GDP,equityandpropertyprices).

49

CausesofCrises2  Logitanalysis(Demirgüc-KuntandDetragiache(1998))–  Theyemphasizetheroleoffinancialliberaliza6oninenvironments

withweakregulatorycapacityandweakins6tu6ons.–  Depositinsuranceandguaranteeleadtoregulatoryforbearanceand

crises.

•  RecentresearchbyBussiereandFratzscher(2006),Babeckýetal.(2014),RoseandSpiegel(2012)findthattheearlywarningindicatorsbyKaminskyandReinhart(1999)donotholdupforrecentcrisis.

•  IMF(2009)findsconsiderableheterogeneityacrosscountriesonthecausesofcrises.

50

CausesofCrises

•  RecentresearchbyCaballero(2014)findsthatcapitalinflowbonanzasandcreditboomsaresignificantpredictorsofbankingcrises.

•  Insum,theliteraturefindsthatmanyfactorsinaddi6ontothegrowthofcreditcanexplainfinancialcrises.

51

OutputLossesofFinancialCrises

•  Mostoftheliteratureagreesthatcrisesareassociatedwithsignificantoutputlosses.

•  Table3summarizestheliteratureontheimpactoffinancialcrisesonoutput.

•  Outputlossisdefinedasdevia6onfromapre-crisispeakinoutputorapre-crisisoutputtrend

52

53

54

55

OutputLosses•  Thekeyissueiscausality.Realshocksmaycauseoutputto

declineleadingtoproblemsinthefinancialsector.•  Butfinancialshockscangenerateoutputdeclines.•  Bordoetal(2001)comparedrecessionswithoutfinancial

crisistorecessionswithfinancialcrises.•  Theyfoundthatfinancialcrisesareassociatedwithhigher

outputcosts.•  Jordà,SchularickandTaylor(2013)reportsta6s6callyand

economicallysignificantdifferencesbetweenoutputdownturnsassociatedwithfinancialcrisesanddownturnsnotassociatedwithfinancialcrises,evena\ercondi6oningonanumberofpredeterminedmacrovariables.

56

OutputLosses•  UsingcrisisdatesfromBordoetal,ReinhartandRogoffandLaevenandValenciaandoutputpercapitafromBarroandUrsua(2008)wecalculateoutputlossesindifferentperiods.

•  Weuseonemethodologytocompareoutputlossesinaconsistentfashionoverthelong-run.

•  Westudythecumula6vedevia6onofpercapitaGDPfromtheprecrisistrendlevelfromtheoutbreakofthecrisisto3yearslater.

•  PrecrisistrendisgivenbytheaveragechangeinlogpointsofthelogofrealpercapitaGDPupto10yearsbeforethecrisis.

57

0

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Bordo et. al Reinhart & Rogoff Laeven & Valencia

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Banking Crises Twin Crises Triple Crises

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ren

d

Ou

tpu

t, (

% x

100

)

Bordo et. al. Reinhart & Rogoff

0

10

20

30

40

50

60


Cu

mu

lati

ve D

evia

tion

fro

m T

ren

d

Ou

tpu

t, (

% x

100

)

Bordo et. al. 55 ctrs. 1973-1997 Reinhart & Rogoff 70 ctrs. 1973-2012

Laeven & Valencia (1973-2012)

-15

-10

-5

0

5

10

15

20


Cu

mu

lati

ve D

evia

tion

fro

m T

ren

d

Ou

tpu

t, (

% x

100

)

Bordo et. al Reinhart and Rogoff

Figure 3a Output Losses for Three Varieties of Crises 1880-1913 Bordo et. al. vs. Reinhart & Rogoff

Figure 3b Output Losses, Three Varieties of Crises 1919-1939 Bordo et. al. and Reinhart & Rogoff

Figure 3c Output Losses, Three Varieties of Crises 1973-1997 (Bordo et. al.), 1973-2012 (Reinhart and Rogoff), 1973-2012 (Laeven and Valencia)

Figure 3d Output Losses from Banking Crises 1973-1997 Three Data Sets.

Notes to Figures 3a-3d: Output losses are claculated as the difference between the level of GDP per capita in the three years following a crisis and the extrapolated trend of GDP per capita. The trend is calcuated as the average growth rate in the 10 years prior to crisis. See the text for additional information.

OutputLosses

•  Lossesarelarge:1880-1913,3-6%;interwar,40%;postBreeonWoods,14-29%.

•  Therangeoflossesreflectsdifferentsamplesofcountries,differentfiltersacrossthedifferentstudies.

•  Figure4onnextslideprovidessomecountryexamples.

59

60

2.4

2.6

2.8

33.

2

ln(G

DP

/PO

P.)

1902 1904 1906 1908 1910 1912year

Trend of ln(GDP/POP.) ln(GDP/POP.)

USA, Crisis of 1907

3.2

3.4

3.6

3.8

44.

2

ln(G

DP

/PO

P.)

1885 1890 1895year


Argentina, Baring Crisis, 18902.

82.

93

3.1

3.2

ln(G

DP

/PO

P.)

1926 1928 1930 1932 1934 1936year


France, Great Depression

2.6

2.7

2.8

2.9

33.

1

ln(G

DP

/PO

P.)

1926 1928 1930 1932 1934 1936year


USA, Great Depression

Figure 4a GDP per person Actual and Counterfactual, USA, 1907 Figure 4b GDP per person Actual and Counterfactual, Argentina, Baring Crisis

Figure 4c GDP per person Actual and Counterfactual, France, Great Depression Figure 4d GDP per person Actual and Counterfactual, United States, Great Depression

61

4.2

4.3

4.4

4.5

4.6

ln(G

DP

/PO

P.)

1986 1988 1990 1992 1994 1996year


Sweden, 1991

4.2

4.4

4.6

4.8

5

ln(G

DP

/PO

P.)

1996 1998 2000 2002 2004 2006year


Argentina, 1991

Figure 4e GDP per person Actual and Counterfactual, Sweden, 1991 Figure 4f GDP per person Actual and Counterfactual, Argentina, 2001

Notes to Figures 4a-4f: Data are underlying Bordo et. al except for Figure 4f. Data real GDP per capita for Figure 4f are from the World Economic Outlook database. Trend (counterfactual) line is calculated based on simple extrapolation of the average growth rate in the previous 10 years.

OutputLosses

OutputLosses•  Onesurpriseisthatoutputlossesseemtobelargerinthe

recentperiodcomparedtopre-WWI,despitetoday’smonetaryauthori6esrelianceonliquiditysupport,fiscalinterven6onsandotherpoliciestoremedythemarketfailuresassociatedwithfinancialshocks.

•  Perhapsthepre-1914economiesweremoreflexibleandthefinancialsectorsmaller.

•  Thelossestodayarelowerthanintheinterwarwhenpolicywascounterproduc6ve.

•  Aninteres6ngavenueforfutureempiricalresearchistostudythesizeofoutputlossesa\erproperlyaccoun6ngforvarianceinpolicyac6on.

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Empirics:FiscalCrisesandBankingCrisesandtheFiscalCrisisTrilemma

•  Recentresearchhasfocusedontheimpactofbankingcrisisontheprobabilityofadebtcrisis,especiallyinadvancedcountries

•  AverageriseinthedebttoGDP(LaevenandValencia,2013)– allsystemiccrises=12%– advancedeconomies=21.4%.– Averageriseindebtduetobailouts,rescuesandguarantees=6%

63

Empirics:FiscalCrisesandBankingCrises

•  Tagkalakis(2013)empiricallyexaminesthefeedbackloopfromfiscalpolicytofinancialmarketsandbackinasampleof20OECDcountries1990-2010.

•  Fiscalinstabilityleadstofinancialinstabilityandfinancialinstabilityleadstofiscalinstabilityviabailouts.–  Riseindebt/deficitsdependsposi6velyonthefinancialsector

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FiscalTradeoffsFinancialDevelopmentandFinancialCrises

•  Tagkalakis(2013)resultssuggestthepossibilityofatradeoffforcountriesalongthelinesofatrilemma

•  Assumethatmostfinanciallydevelopedcountrieswillinevitablyfaceacrisisatsomepoint

•  Twooutofthreechoicesmaybepossible

–  Largefinancialsector–  Debt-financedrescuesofthefinancialsectorduringafinancialcrisis

–  Counter-cyclical/discre6onaryfiscalpolicyduringfinancialrecessions

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FiscalTradeoffs,FinancialDevelopmentandFinancialCrises

•  Logic:acountrywithalargefinancialsectorwillbemorelikelytohavefinancialcrisis

•  Ifsothegovernmentcaneitherprovidealargebailoutpackageanduseupfiscalspace

•  Orelseitcouldreducethesizeofthebailoutanddevoteitsfiscalspacetodiscre6onaryfiscalpolicy

•  Thesmallerthefinancialsectorthelessbindingwillbethefiscalconstraintssincethesizeofthebailoutwouldbesmaller

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•  EgUSpost2007hadalargefinancialsectorbutitsbailoutwasrela6velysmallat4.5%ofGDP

•  ThedebtGDPra6oroseby19%•  VersusGreecewhichhadariseinthedebtra6oby17%but

amuchlargerrecessionandthefiscalbailoutcostswere27%(whichdoesnotincludetheexternalrescues)

•  Theabilityofcountriestofinanceeitherabailoutorusediscre6onaryfiscalpolicydependsonthewillingnessofcapitalmarketstofunddeficits

•  Thusthetrilemmaismoreapplicableforcountrieswhichhavebeeerdebtsustainabilityatthebeginningoftheircrisis

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•  TotestthefinancialdilemmaweusedatafromLaevenandValencia(2012)for19bankingcrisesin18advancedcountriessince1970.

•  Weusethefollowingregression:

•  Discre6onisthechangeintheDebt-to-GDPra6ominusthera6ooffiscalcoststoGDP.

68

ln Δ!"#$!"!"#!" = ! + !! ln Δ!"#$%& !"#$#!"!"#!" + !! ln Δ!"#$%&'"()!"!"#!" + !!"

Results

69

•  Theresultssuggestthatthecoefficientsonthetworegressorsadduptooneandimplyatradeoffbetweenbailoutanddiscre6on.

•  Figure5plotthepredictediso-lineatgivenlevelsofthechangeinthera6oofDebt/GDPaswellasthedataforthe18countriesand19crisesinthesample.

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Results

-5

5

15

25

35

45

55

0 10 20 30 40 50 60(Cha

nge

in D

ebt/

GD

P -

Fis

cal C

osts

/GD

P)

x 10

0

(Fiscal Costs of Bailout/GDP) x 100

Data D (Debt/Y) = 12D (Debt/Y) = 30 D (Debt/Y) = 20D (Debt/Y) = 45 D (Debt/Y) = 70

Figure 5 Fiscal Costs of Bailouts vs. the Rise in Government Debt/GDP from other Non-Bailout Costs, 19 Crises, 1970-2012

Notes to Figure 5: Data are from Laeven and Valencia (2012). Iso-lines are the predicted values for the debt to GDP ratio from equation (1).

Results

71

•  Theriseinthera6oofDebt/GDPmatchesthedatarela6velywell.

•  Weinteractedthefiscalcostsvariablewiththesizeofthefinancialsector(domes6cprivatecreditoverGDP).

•  Theposi6veinterac6ontermimpliesthatcountrieswithlargefinancialsectorsdevotemoreoftheirfiscalspacetobailouts.

Results

72

•  AunivariateregressionshowedthattheshareoftheriseintheDebt-to-GDPra6oaccountedforbybailoutswasaposi6vefunc6onofthesizeofthefinancialsector.

•  Seefigure6.

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Norway

Belgium

Italy

Greece

Finland

France

Austria

Germany

LuxembourgNetherlands

United States

Sweden

Sweden

Ireland

United Kingdom

Denmark

Iceland

United States

Japan

-2-1

01

2

Shar

e of

Ris

e in

Deb

t/Y o

n ba

ilout

- log

it tra

nsfo

rm

-1 -.5 0 .5ln (domestic credit/Y)

coef = .7326351, (robust) se = .55373397, t = 1.32

Figure 6 Fiscal Costs of a Bailout as a share of the Rise in Debt-to-GDP vs. Size of the Financial Sector

Notes for Figure 6: Figure presents the predicted regression line/partial regression plot from a univariate regression of the share in the rise in debt as a percentage of GDP against the logarithm of the level of private domestic credit to GDP. We perform a logit transform on the dependent variable prior to estimation. Debt data are from Laeven and Valencia and the credit data are from IMF IFS.

Results

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•  Therefore,asthesizeoffiscalbailoutsincreases,thediscre6onarycomponentofthefiscalresponseissmaller.

•  Largefinancialsectorsnecessitatelargebailouts.Hence,ifcountrieshadsmallfinancialsector,theconstraintsondiscre6onaryfiscalac6onswouldbelessbinding.

Results

Conclusions•  Thehistoryoffinancialcrisesshowsacrisissomewhereinthe

worldabouteverydecade.

•  FiscalandfinancialcriseshavebeenincreasinglylinkedtogetherbytheincreaseduseofgovernmentguaranteesofFIs.

•  Toavoidthecostsofold-fashionedbankingpanics,governmentrescueshasledtomorevirulentmodernbankingcrises.

•  Thisreflectsthegeneralphenomenonthat,whenthegovernmentintervenestopreventcostlyeventsfromoccurring,theneconomicagentsadjusttheirbehavioraccordinglyandusemoreoftheprotectedresourcethanisinthelong-runop6mal.

•  Thereisatrade-offbetweenthecostsoffinancialcrisesthataccompanyfinancialdevelopmentandgrowthandthemoralhazardcostsofinsurance.

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Conclusions•  Elimina6ngcrisesen6relyisnotdesirable,butlenngthemburn

outisalsonotideal.•  Thetheore6calliteraturehasevolvedwiththehistoryofcrises.•  Possibleques6onsforfutureresearchinclude:

–  Whatdoweknowaboutop6malbankregula6on,macro-pruden6alpolicyandthepoli6caleconomyofresolu6on?Whatdoweknowaboutthemarketfailuresthatgenerateneedforsuchinterven6ons?

–  Ifitishardtopredictfinancialcrises,canmacro-pruden6alpolicyandfiscalrulesbereliable?Empiricalresearchbasedoncross-countrypaneldatasetshasonlyjustbegunhere(e.g.Cerun,ClaessensandLaevenforthcoming).

–  Whatroledoesfiscalspaceplayintheresolu6onphaseofsystemicfinancialcrises?

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Conclusions

–  Isthewayinwhichresolu6onproceedsdependentuponini6alcondi6onsandotherins6tu6onalconstraints?

– Whatkindsoffiscalunionarefeasiblebotheconomicallyandpoli6callyinmonetaryunionandhowimportantarefiscalconstraintsundersucharrangements?Whatfiscalarrangementsarefeasibleandefficientinamonetaryunionfacingsystemicshocks?

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Conclusions•  Oursurveyoftheempiricalevidencerevealcrucialdifferencesover

thedefini6onofcrisesamongtheleadingapproachesintheliterature.

•  Thishasledtodifferentchronologiesoftheincidenceofcrises.•  Thiscreatesproblemsforpolicymakers:whoshouldyoubelieve?•  Pickingthewrongapproachcanleadtoincorrectpolicy

prescrip6ons.•  Maybeweshouldhaveanindependentcrisisda6ngcommieeelike

theNBERbusinesscycleda6ngcommieee.

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Conclusions•  Oursurveyalsoshowedgreatdifferenceinmethodologiesand

techniquesinthemeasurementofoutputlosses.•  Butallagreethatcostsofcrisesarehighandgrowing.•  Wes6lldonothaveaclearunderstandingofthemagnitudeofthe

impactofpoliciesintendedtomi6gatecrises.•  Itisnotatallobviousthatcreditfinancedassetpriceboom-busts

(thefinancialcycle)isalwaysthekeyexplana6onforcrises.•  Overemphasisonafewindicatorscanmisleadinganddangerous

forfinancialstability.•  Wealsodonotfullyunderstandtheconnec6onbetweenfinancial

development,fiscalresolu6onsofcrisesandoverallfiscalgoals. 79

Fiscal and Financial Crises · – O\en occurred with the failure of an important ﬁnancial...

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