economic resilience: trade-offs between growth and ... · efficiency channel fragility channel...

ECONOMIC RESILIENCE:

TRADE-OFFS BETWEEN

GROWTH AND ECONOMIC

FRAGILITY

Filippo Gori Economics Department, OECD Policy Challenges in the Global Economy NERO Meeting, Paris, 19 June 2017

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Financial crises and deep recessions have been frequent

0

2

4

6

8

10

12

14

16

18

20

1970 1975 1980 1985 1990 1995 2000 2005 2010

Banking, currency or sovereign debt crises Severe recessions

Note: The chart refers to crisis and severe recession episodes for 35 OECD countries over the period 1970Q1-2010Q4. Crisis

episodes are from Babecky et al. (2012).

Source: OECD calculations based on Babecky et al. (2012) data and Hermansen and Röhn (2015) for severe recessions.

120 episodes of

financial crisis and

over 100 cases of

severe recessions

Number of OECD countries affected during each episode

0

2

4

6

8

10

12

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Unemployment rate

Japan United States European Union (28 countries)

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Crises might have long-lasting effects

Per

cen

t

Source: OECD.stat

Pre-crisis Levels

GDP growth

• Measures should be taken to reduce economic fragility.

Risk mitigation is key, but….

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Economic

fragility

• However we should be aware of the growth consequences of risk reducing policies

Economic

fragility

Fragility

GDP

Growth

• Risk-mitigation needs to be balanced against potential cost of economic growth

Benefits and costs of risk mitigating policies should be considered

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Crisis

Risk

• Banking crisis

• Currency crisis

• Twin crisis

vs GDP growth

extreme negative

GDP growth rates

vs

mean GDP growth

Paper I Paper II

Tail

Risk

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0 GDP growth

Extreme negative growth

Tail risk = the risk of an extreme negative growth shock

GDP-at-Risk = quantile of the

GDP growth distribution

i.e. max GDP loss with 95% prob.

Approach I: growth and GDP tail risk

Theoretical quantiles of normal distribution

Extreme negative growth events not uncommon...

United States United Kingdom

7

Netherlands

Extreme

negative

growth rates

Extreme

positive

growth rates

𝑄𝜏 𝑦𝑡|𝑋𝑡 = 𝑋𝑡 𝛽(𝜏)

𝛃 𝛕 : effect on the τth quantile of y due to a marginal change in X (e.g. for 𝜏 = 0.05 => the impact on the 5-percent GDP-at-risk).

𝒚: quarterly GDP growth.

𝑿: factors that can influence the GDP growth distribution:

1) country characteristics (size, stage of development, trade openness)

2) macro policies (size of automatic stabiliser, real short-term interest rate)

3) structural policies

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Conditional quantile regression

Unbalanced panel with a maximum of 42 countries, mostly OECD, over the period 1970-2014


9 Policy variable

Positive effect on growth

GD

P g

ro

wth


Conditional quantile regression an illustration

Increase in tail risk

x1 x2

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The diamonds depict the point estimates and the thick bars a confidence interval of +/- 1 standard deviation. The horizontal blue line depicts the OLS estimate. Source: Authors’ calculation based on Caldera Sánchez and Röhn (2016).

The relationship between government effectiveness, mean growth and GDP tail risk


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The relationship between active labour market policies, mean growth and GDP tail risk


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Policies

Growth

Crisis Risk

Possible fragility channel

Growth Channel (efficiency channel)

Financial liberalisation

Capital account openness

Trade openness

Exchange rate regime

Product Market Regulation (PMR)

Tax settings

…

Approach II: growth and crisis risk

• A growth regression

Growthiτ= policyit + controlsit + εiτ

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Growth

Growth Channel

Crisis Risk

Possible fragility channel • Nested with a probability model:

Pr(Crisisiτ)= policyit + controlsit + μiτ

(Similar to Ranciere Tornell Westermann (2006) – a treatment effect model (Maddala 1983)

Sample: panel of 100 countries, 1970-2010)

Growthiτ= policyit + controlsit + Pr (𝐶𝑟𝑖𝑠𝑖𝑠𝑖𝜏)+ εiτ

2 SLS estimation

Crisis Risk

Systemic banking crisis

Currency crisis

Twin crisis


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Approach II: growth and crisis risk G

row

th (

perc

enta

ge p

oint

s)

Crisis risk (red line) percent

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0.1

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0.6

0.7

0.8

0.9

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

Financial marketsopenness

Capital accountopenness

(Less) Reg. in 7 non-manufacturingnetwork-ind.

Adjusted statutorycorporate income tax

rate

Efficiency and fragility channel

Direct growth effect (efficiency channel) Crisis risk (fragility channel) - right axis

Growth and crisis risk, an illustration

RESULTS

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Lower growth and lower fragility

Higher growth and lower fragility Higher growth and fragility

Lower growth and higher fragility -0.50

-0.30

-0.10

0.10

0.30

0.50

-0.88 -0.68 -0.48 -0.28 -0.08 0.12 0.32 0.52 0.72

Gro

wth

(Y

axi

s)

Fragility (X axis)

Note: The X axis plots the effect on fragility, defined as a higher likelihood of financial crises (currency, banking or twin crises) or a higher GDP (negative) tail risk., where tail risk is defined as the effect on the bottom 10% of the distribution of quarterly GDP growth. The Y axis plots the effect of a policy variable on growth. Source: OECD calculations in Caldera Sanchez and Gori (2016) “Can Reforms promoting growth increase financial fragility? An empirical assessment” and Caldera Sanchez and Roehn (2016) “How do policies influence tail risks?”

A growth-fragility space…

Policy areas outside the financial sector do not involve growth-fragility trade-offs

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The X axis plots the effect on fragility; Fragility is defined as higher likelihood of financial crises (polices with red outline) or a higher GDP (negative) tail risk.

Three types of financial crises are considered: Currency, banking and twin crises. Tail risk is defined as the effect on the bottom 10% of the distribution for

quarterly GDP growth. For each policy, the Y axis plots the average (overall) growth effect.

Source: Authors’ calculation based on Caldera Sánchez and Gori (2016) and by Caldera Sánchez and Röhn (2016).

Pro-growth

product and labour

market policies

have little or no

impact on fragility

Better-quality

institutions associated

with higher growth

and lower fragility

More trade-offs are found in the area of financial market policies

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Source: Authors’ calculation based on Caldera Sánchez and Gori (2016) and by Caldera Sánchez and Röhn (2016).

Macro-prudential

policies can reduce

fragility, but may also

lower growth

Growth benefits from

financial market

liberalisation offset

by higher crisis risk

Capital account openness increases both growth and economic fragility..

Composition of capital flows matters

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Growth benefits from

capital account

openness outweigh

crises risks

Fragility linked to

portfolio debt

inflows




Source: Authors’ calculation based on Caldera Sánchez and Gori (2016)

• Product and labour market policies

• Enhance growth, little impact on crisis risk.

• However a growth-fragility trade- off exists in other policy

areas: Financial market liberalisation

• Pro-growth impact of reduced by crisis risks, which are driven by

=> Excess private credit growth

Misalignments in real estate markets

Capital account openness

• Pro-growth effects of greater outweigh crisis risk

=> Risk mainly associated with portfolio debt flows.

Macro prudential necessary but may entail some costs.

Concluding remarks

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Lower growth and lower fragility

Higher growth and lower fragility Higher growth and fragility

Lower growth and higher fragility -0.50

-0.30

-0.10

0.10

0.30

0.50

-0.88 -0.68 -0.48 -0.28 -0.08 0.12 0.32 0.52 0.72

Gro

wth

(Y

axi

s)

Fragility (X axis)

Financial Markets

Quality of institutions

Labour Markets

Product Markets

Macro prudential

policies

Note: The X axis plots the effect on fragility, defined as a higher likelihood of financial crises (currency, banking or twin crises) or a higher GDP (negative) tail risk., where tail risk is defined as the effect on the bottom 10% of the distribution of quarterly GDP growth. The Y axis plots the effect of a policy variable on growth. Source: OECD calculations in Caldera Sanchez and Gori (2016) “Can Reforms promoting growth increase financial fragility? An empirical assessment” and Caldera Sanchez and Roehn (2016) “How do policies influence tail risks?”

Sum-up: evidence on growth-fragility

OECD Resilience website

http://www.oecd.org/economy/growth/economi

c-resilience.htm

BACK UP

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-0.6

-0.4

-0.2

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-0.6

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-0.2

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Capital accountopenness

FDI Portfolio equity Portfolio debt Other flows

Effect of capital flow on growth and crisis risk

Efficiency channel Fragility channel Overall growth Crisis risk

Capital flows composition

Gro

wth

(pe

rcen

tage

poi

nts)

Crisis risk (red line) percent

Growth and crisis risk, an illustration

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The relationship between active labour market policies, mean growth and GDP tail risk


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