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  • GLOBAL FINANCIAL CRISIS: Causes and Consequences

    Hyeongwoo Kim

    Auburn University

    October 30, 2010

    Prepared for the 4th KSEA-AL Symposium on Automotive Technology

  • US Financial CrisisUS Financial Crisis

    The collapse of the

    US sub-prime

    mortgage market in

    2007 triggered a global 2007 triggered a global

    financial crisis.

    The failure of Lehman Brothers resulted in a serious

    disruption in international financial markets. Stock prices (level, sd)

    Exchange rates (level, sd)

  • Global RecessionsGlobal Recessions

    This US financial crisis triggered recessions not only in

    the US but also in the rest of the world.Real GDP growth rates (Fig) Real GDP growth rates (Fig)

    Unemployment rates (Fig) Still very high in the US (Unemployment durations )

    Inflation rates (recessions) after initial increases

    (expansionary M policies) (Fig)

  • Policy makers tried to stop it, but less

    successful Expansionary monetary policies

    Interest rate cuts (short, long)

    Quantitative easing (US)

    Policy ResponsesPolicy Responses

    Quantitative easing (US)

    Expansionary fiscal policies Stimulus checks

    Cash for clunkers

    Government spending vs. tax cuts

    Private sectors did not respond as expected Consumption (Fig) and Investment (Fig) barely

    responded.

    International trade shrank (Fig).

  • Causes and ConsequencesCauses and Consequences

    The profession seems to agree on that the

    crisis was triggered by the collapse of the US

    sub-prime mortgage market. Then, natural

    questions are,

    Why did it collapse?

    The value of the US sub-prime mortgage market

    is tiny (6.7% of total mortgage debt in 2009).

    Why did it spread to,

    Other financial industries?

    Other non-financial industries?

    Other countries?

  • Causes of the CrisisCauses of the Crisis

    Why did it collapse?

    Housing price bubble

    Unsustainable (Fig)

    Bubble is supposed to burst.

    Some blame Greenspan unclear (Fig) Some blame Greenspan unclear (Fig)

    Overall asset bubbles around 2000

    (Fig)

    Securitization (financial

    innovations, loophole mining)

    Excessive leverage (off-balance

    sheet activities)

    Moral hazard (too big to fail)

  • Other Financial SectorsOther Financial Sectors

    Financial activities are highly intertwined.

    The Glass-Steagall Act (Banking Act of 1933) were repealed,

    Depository Institutions Deregulation and Monetary Control Act of

    1980 (Regulation Q)

    The GrammLeachBliley Act (November 12, 1999; Bank-holding The GrammLeachBliley Act (November 12, 1999; Bank-holding

    company)

    Virtually no separation of banking from securities industry now

    Update: President Obama signed the Dodd-Frank financial regulation

    reform bill (July 21, 2010).

    The collapse of the sub-prime mortgage market quickly

    spread to other financial industries.

  • NonNon--Financial Real SectorsFinancial Real Sectors

    Spill-over effects to non-financial

    industries

    Caused by liquidity crunchCaused by liquidity crunch

    Excess reserves (Fig)

    Money multiplier (Fig)

    Higher borrowing costs due to high

    degree uncertainty

    Risk premium (Fig)

    Credit default swap

  • Contagion to Other CountriesContagion to Other Countries

    Financial markets are highly integrated across countries

    (Financial channel)

    De-regulation (can be costly, Korea vs. China in 1997)

    Shares of foreign investors

    Mrs. Watanabe (Fig)

    Substantial increases in volumes of international trade

    (Real activities channel) (Fig)

    Supposed to be good (comparative advantage)

    May become vulnerable to foreign shocks

    Exchange rate shocks (highly volatile and persistent)

  • Contagion to Other CountriesContagion to Other Countries

    Highly integrated international economies may imply,

    Higher degree co-movement in 2000s

    Coupling phenomenon

    Static synchronization (Fig)

    Temporary dynamic correlations (Fig) Temporary dynamic correlations (Fig)

    Severer and more persistent adverse effects of a foreign

    shock in 2000s.

    Dynamic synchronization (Fig)

    1% in the US stock price 0.5% and 2% in German stock

    prices in the 1970s and in the 2000s, respectively, in the long-run.

    More Significant adverse effects in the 2000s both quantitatively and

    qualitatively

  • Policy ImplicationsPolicy Implications

    Kim and Kim (2010a,

    2010b) studied the recent

    US financial crisis and

    identified the channels of

    contagion in international contagion in international

    financial markets.

    Contagion occurred

    abruptly and lasted for a

    short period of time.

  • Policy ImplicationsPolicy Implications

    Kim and Kim (2010a,

    2010b) studied the recent

    US financial crisis and

    identified the channels of

    contagion in international contagion in international

    financial markets.

    Substantial level effect

    Stock prices (level)

    Exchange rates (level)

  • Policy ImplicationsPolicy Implications

    Kim and Kim (2010a,

    2010b) studied the recent

    US financial crisis and

    identified the channels of

    contagion in international contagion in international

    financial markets.

    EWS, Currency Swap

    Agreements

    Strengthen the roles of

    domestic agents in

    financial markets

  • Thank you.Thank you.Thank you.Thank you.

  • Stock Prices

  • Stock Returns Volatility

  • Foreign Exchange Rates

  • FX Depreciation Rates Volatility

  • Real GDP Growth Rates

  • Unemployment Rates

  • CPI-based Inflation Rates

  • Overnight Inter-bank Rates

  • 10-Year Government Bond Yields

  • Real Consumption Growth

  • Real Investment Growth

  • Exports-Imports Growth

  • US Money Growth

  • Housing Price and Fundamentals

    500

    600

    700

    800

    900

    1000

    150

    200

    250

    Po

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    in

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    Ind

    ex o

    r In

    tere

    st R

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    Home Prices

    0

    100

    200

    300

    400

    500

    0

    50

    100

    1880 1900 1920 1940 1960 1980 2000 2020

    Po

    pu

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    Ind

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    Year

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    Interest Rates

    Source: Irrational Exuberance (2nd Edition), Robert J. Shiller

  • Interest Rates

  • Commodity Prices

  • Risk Premium

  • US Trade Openness

  • Mrs. Watanabe

  • Excess Reserves

  • Money Multiplier

  • Stock Market Synchronization

  • BEKK Conditional Correlations

  • Impulse-Response Analysis