Transcript Document

Boom-bust and banking crises in Finland,
Norway and Sweden, 1984-1994:
Important lessons
Main issues
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Boom-and-bust cycles
Financial liberalization and macroeconomic instability
The critical years, 1984-1992
Financial deregulation and the lending boom
Bad banking
The boom-bust cycle and fiscal policy
Monetary policy
The asset price bubble
The government’s handling of the banking crisis
Conclusions
Lessons
Boom-bust cycles and financial crises
(not a complete list)
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Norway (1991-1993)
Finland and Sweden (1992-1994)
Japan (1990s)
Mexico (1994-1995)
East-Asia (1997-1999)
Argentine (2000-2002)
USA (2007-?)
UK (2007-?)
Iceland (2008-?)
The experience of Finland, Sweden and
Norway; 1984-1994
• Financial deregulation
• Fast growth in lending, consumption, investment and asset
prices
• A business cycle boom
• The asset bubble bursts (triggered by a stochastic ”shock”)
• Decline in consumption and investment
• Recession
• Financial crisis/a speculative attack on the fixed exchange
rate
• Government rescue of banks
• New monetary policy aiming at low inflation
• Economic recovery.
Boom-and-bust cycles
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Business cycles before WW I.
The boom ends with a burst of asset bubbles and a financial crisis.
Asset prices are linked to booms and recessions.
Banks and the market for loans are essential elements of the boomand-bust cycle.
Knut Wicksell and Ragnar Frisch: The behavior of banks is
procyclical and potentially destabilizing.
Most economists after WW II believed that boom-bust cycles could
be eliminated by appropriate aggregate demand management.
This belief was far too optimistic
Financial globalization: The return of the boom-bust cycles and
financial crises
The boom-bust cycle
(Norway 1984-1993)
Employment Mainland, 1970-2001
(1000 man-years)
2500
Total Mainland
2000
Private sector
1500
Public sector
1000
Linear (Private
sector)
Linear (Total
Mainland)
500
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 0
year
The critical years (Norway)
Year
84
85
86
87
Fin.sector
Exch.rate
income p.
Fin.
lib.
Fin.
lib.
Deval.
Monetary
policy




Fiscal
policy




88
89
wage
regul.
wage
regul.
90
ecu







Asset
prices
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

Business
cycles
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




91
Bank
crisis




92
Curr.
crises
93
Man.
float
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
Tax
reform





Important questions
• Why did previously very stable Nordic countries become so
ustable?
• Why did the deregulation of the credit market trigger such a great
credit supply shock?
• Could the financial supervision authorities have prevented bad
banking and the banking crises?
• Was fiscal policy procyclical?
• How important was the exchange rate policy and monetary policy?
• How well did the government handle the banking crisis?
• Was there a credit crunch?
• Did international business cycle impulses increase fluctuations?
Inherited economic policy errors from the
1970s in Norway
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A considerable foreign debt
A new oil price shock and large exposure to oil price risk
Increasing inflation and unemployment
No political acceptance of the natural rate hypothesis
The fixed exchange rate was not credible
A regulated nominal interest rate, a negative after-tax real
interest rate
Credit regulations and increasing credit market chaos
Underdeveloped capital markets
Strong tax incentives to borrow rather than save
Absence of structual policies to promote economic
efficiency and productivity growth
Framework for analysis of business cycles
Monetary and fiscal
policy
Shocks
(stochastic
impulses)
Propagation
mechanism
Business
cycles
Changes in the propagation mechanism
• Credit market deregulation: Behavioral change, larger interest
rate sensitivity in consumption and investment
• Fluctuations in aggregate demand changed aggregate
output and inflation
• Disinflation was not possible without a recession.
• The NAIRU-mechanism: Excess demand/supply for labor
fuelled wage growth/moderation
• The investment accelerator was important.
• A fixed exchange rate and free capital mobility made monetary
policy procyclical. A flexible exchange rate would have
permitted a stabilizing monetary policy, such as after 1999.
• In open market economies the trade balance regulates itself
over time if fiscal policy is sustainable.
The most important shocks
(Norway)
1. International shocks: International slump and inflation
impulse in the beginning of the 1980s
2. Liberalization of credit triggered a credit supply shock after
1984
3. Trade shock: Oil price decline in 1986. Great loss of
national income
4. Cost shock: Wage settlement in 1986 got out control
5. Interest rate shock: A high German interest rate after
unification
6. International shocks: International slump and the
economiccrises in Sweden and Finland (1990-93)
From low to high real interest rates
(after-tax)
percent
Realrente etter skatt, 1967-2001
10
8
6
4
2
0
-2
-4
-6
-8
-10
Realrente
67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1
year
Bad banking in Norway
* Pressure from the banks to reduce capital requirements
• Financial Supervision and prudential regulation was weak
• Market shares should increase at all cost
• Unrealistic ”visions” and growth ambitions
• Activ ”sales of loans” to speculative projects.
• Low quality of banking, particularly credit risk assessments
• Lack of managerial control
• Enormous credit expansion, excessive banking capacity
• Large losses abroad unrelated to Norwegian economy.
• Many small savings banks were doing fine.
The growth and decline of bank credit
Growth in nominal lending by parent banks, 19811996 (percent per year)
40
percent
30
20
Norway
Finland
Sweden
10
0
-10
-20
-30
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96
year
Bank capital
Capital and reserves in commercial banks, 1980-1999
(in percent of year-end balance total)
8
7
percent
6
5
Norway
4
Sweden
3
Finland
2
1
0
80
82
84
86
88
90
year
92
94
96
98
Real stocks of bank loans in Norway,
Sweden and Finland, 1981-96 (1979=100)
Real stocks of bank loans, 1979-1999 (1979=100)
450
400
350
Index
300
Norway
250
Sweden
200
Finland
150
100
50
0
79
81
83
85
87
89
year
91
93
95
97
99
Profits before tax, 1980-99 in comm. banks
(in percent of total average assets)
Profitability of commercial banks, 1980-1999
3
2
percent
1
0
Norway
-1
Sweden
-2
Finland
-3
-4
-5
80
82
84
86
88
90
year
92
94
96
98
Profits before tax 1980-99 in savings banks
(in percent of total average assets)
Profitability of savings banks, 1980-1999
4
2
percent
0
Norway
-2
Sweden
-4
Finland
-6
-8
-10
80
82
84
86
88
90
year
92
94
96
98
Abundant credit supply trigged a fall in
the household savings rate
percent
Household saving rates, 1980-1995 (percent of disposable
income)
10
8
6
4
2
0
-2
-4
-6
-8
Norway
Sweden
Finland
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
year
Monetary policy (Norway)
• The 10 % devaluation in 1986: ”No more devaluations”
policy of disinflation.
• Gradually tighter monetary policy from 1986
• Full liberalization av capital flows fra 1990.
• From currency basket peg to ecu peg in 1990: It increased the
real interest rate in a slump
• The German unification triggered a high interest rate.
Monetary policy became very procyclical: 1989-1993
• Speculative attacks againts FIM, SEK and NOK. Norges Bank
let the krone float in December 1992. Good for the
Norwegian economy
• 1993-1998: Managed float (”flexible exchange rate targeting”)
• 1999: Inflation target for monetary policy and a flexible
exchange rate.
Procyclical monetary policy due to the fixed
exchange rate
Norwegian monetary policy and the Taylor rule, 19811998
30
percent
25
20
Forward Taylor
15
Taylor
Money market rate
10
5
0
81:1 82:4 84:3 86:2 88:1 89:4 91:3 93:2 95:1 96:4
quarter
Curbing inflation
Inflation (CPI), Norway and Norway's trading partners,
1980-2001 (percent)
Norw ay
Norw ay's trading partners
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
16
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
Conclusions from international research
(Kaminsky & Reinhart, 1996, 1999)
The typical order of events (study of 20 countries,
including the three Nordic):
1. Financial deregulation
2. Fast credit expansion
3. Rapid increase in asset prices
4. Collapsing asset prices (the bubble bursts)
5. Banking crisis and currency crisis (about one
year later)
6. Macroeconomic crisis at about the same time
(lasting about 1½ years)
A theory of financial crisis
(Allan & Gale, Economic Journal 2000)
• Market failure in financial sector is the cause of credit financed
bubbles.
• Limited liability and agency problem: Investment decisions are made
on behalf of savers.
• Limited liability: Borrower/investor gets the benefits of lucky
outcomes. Lender/saver bears down-side risk.
• Risk shifting: Investors take greater risk than what savers wish.
Information problem prevents control by savers.
• Price bubble: Credit finance of speculative investment in assets
leads to higher asset prices than their fundamental values.
• Expectations important: The bubble expands due to expectations of
future credit growth.
• Start of bubble: Financial deregulation: easy credit for speculation
• Burst of bubble: A negative real shock or monetary restraint.
• Note: The theory predicts that the problem is largest in markets for
shares and commercial real estate.
Complementary explanations
of asset price bubbles
• Deposit insurance could stimulate credit financed
speculation even further.
• Herd behaviour: Under limited information it could
be rational to do as the other bankers do.
• Management failure: Managers of banks did not
know how to manage banks in a new competitive
environment.
• Non-rational behaviour: More recent research in the
bordering areas of economics and psychology. A
promising area of research.
Real estate price bubbles in Oslo and Stockholm.
Non-residential real estate.
Real estate real price bubbles in Oslo (1981=100) and
Stockholm (1983=100)
300
250
index
200
Oslo
150
Stockholm
100
50
0
0
1
2
3
4
5
6
7
8
year
9 10 11 12 13 14 15
Capital Injections or Transfers to Banks
from Insurance Funds and Governments, 1988-1993
Source: S.A. Berg (1997)
Country
Equity cap.
Total disof all banks, bursements
end of 1988, 1988-1993
excl. subord.
debt
Number of
receiving
banks,
1988-1993
Total
number of
banks, end
of 1988
Norway
(mill. of Nkr)
22,831
24,912
25
187
Sweden
(mill. of Skr)
19,414
65,000
3
525
Finland
(mill. of Fmk)
22,760
54,278
278
590
Denmark
(mill. of Dkr)
65,088
5,092
7
206
Present values of fiscal costs and revenues
in 2001
Government capital injections
Gross
fiscal
cost
Revenue
Net
revnue
Present value per 31.12.2001
(mill. kroner)
(risk-adjusted interest rate)
51.1
56.9
5.8
Per cent of GDP in 2001
3.4
3.8
0.4
Present value per 31.12.2001
(mill. kroner)
(isk-free interest rate)
39.7
53.4
13.7
Per cent of GDP in 2001
2.6
3.5
0.9
Government handling of the banking problems and
crisis management (Norway)
• Early warning:
• Increasing losses in non-bank finance companies in 1986 og
1987. A sign of ”bad banking” behavior
• Phase 1 (1987-1990):
• Problems in some very aggressive and fast-growing banks.
Solved by the bank’s Insurance funds, as well as mergers and
closures.
• Phase 2 (1991-1992) The banking crisis
Collaps of the three largest commercial banks. Quick government
rescue by the Government Bank Insurance Fund and the
Government Bank Investment Fund.
Was the Norwegian government’s rescue strategy
appropriate in a macroeconomic perspective?
• Allen & Gale (1999) compare Norway and Japan:
• Norway:
• ”the government’s prompt action in restoring the banking system
meant that it was quickly able to revert to performing its normal
economic function.”
• Japan:
• ”The reaction of the Japanese government was initially in stark
contrast to what happened in Norway. (…) the government did
not provide funds. This meant that banks slowly had to make
provisions for bad loans from operating income and unrealized
profits on stock holdings. (…) In Japan the presumption was that
that economic growth would return and this would solve the
banking problem. (…) it appears that the direction of causality is
the opposite of that assumed in Japan. A solution to the banking
problem is necessary to restore growth.”
Crisis and recovery 1990-1995
Year
Real
domestic credit
growth
(%)
Real
growth
of bank
lending
(%)
Real
after-tax
interest
rate
(%)
Growth
of
relative
housing
price
(%)
Real
GDP
growth
(%)
Real
Mainland
GDP
growth
(%)
1990
1991
1992
1993
1994
1995
1.6
-3.7
-5.8
-4.6
-0.3
1.4
3.9
-5.0
-5.9
-2.0
4.5
6.1
4.6
5.3
7.3
5.4
4.5
3.1
-8.2
-10.6
-7.4
3.7
9.4
4.5
2.0
3.1
3.3
2.7
5.3
4.4
1
1.4
2.3
2.8
3.8
3.5
Conclusions (1)
1. Why so much macroeconomic instability in 19841993?
• Fixed exchange rate and financial deregulation
• Inherited stagflation and political procrastination of the
1970s. Disinflation leads to a recession. NAIRU-hypothesis
not accepted.
• Assymmetric shocks made monetary policy procyclical
• Shock 1: The credit supply shock due to credit deregulation
• Shock 2: Oil price shock triggered a fiscal restraint and drop
in petroleum investment in the recession
• Shock 3: The German interest rate shock
Conclusions (2)
2. Why did the deregulation of the credit market trigger such a
great credit supply shock in Norway?
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The credit regulations lost their legitimacy and had fostered
cynism among banks: strong desire to grow fast before 1984.
The credit deregulation policy increased competition very
quickly.
Inadequate capital requirements and prudential regulation
The underlying demand for credit was very strong due to the new
housing wealth created by the previous deregulation of the
housing market and the booming stock market (speculative credit
demand)
High degree of forced saving in 1983-84
Conclusions (3)
3. Was fiscal policy stabilizing?
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The government was too worried about structural current
account deficits after the 1986 oil shock: Fiscal restraint
hitting indebted households.
Fiscal restraint policy was continued for too long: Made
the recession and stagnation worse.
New rules for tax deduction of interest payments were
badly timed.
Expansionary fiscal policy in 1991-1993 was very helpful in
boosting household income and start a new upturn.
Conclusions (4)
4. Why no ex post fiscal cost of the Norwegian banking rescue in
contrast to Finland and Sweden?
• The 1986 oil price shock ended a longer-lasting boom and slowed
down borrowing and investment years before the German interest
rate shock. No similar ”early warning” shock in Finland and
Sweden.
• Large oil revenues and low investment improved the Norwegian
current account quickly, low risk premium in the interest rate.
• Expansionary fiscal policy from 1991 without credibility problems.
More procyclical fiscal policy in Finland and Sweden. The
aggregate demand decline was more dramatic in Finland and
Sweden.
• Establishing a separate institution to handle ”bad loans” may
increase the fiscal cost compared to re-capitalizations of banks by
the government.
Remaining questions
1. A credit crunch in 1991-1992?
• Most insiders did not think so, but lack of research leaves the
question unsettled. Macrodata looks better than in
Sweden/Finland
2. Would a good prudential regulation have made a difference?
• Credit financed speculation hard to detect due to information
problems. However: With todays capital requirements, the
crisis would have been much smaller, may be non-existent.
3. International business cycles: Did they make things worse?
• Hardly. The international impulses had marginal stabilizing
effects on Norwegian non-oil exports after 1984.
4. How important were the speculative attacks i 1992
• They permitted lower interest rates and better monetary
polices.
Main lessions
• Financial markets cannot work on their own: Government
institutions and appropriate policies must be in place before
”financial liberalization”.
• Macroeconomic policy should account for that highly
leveraged households and firms could amplify the crisis.
• Households and firms should not borrow in foreign currency
• If banks loose confidence due to heavy losses, they should
be re-capitalized quickly, by government capital injections if
necessary.
• In a banking crisis, don’t garantee all deposits independent
of size. Otherwise, moral hazard could distort the money
market and increase the fiscal cost of a government rescue.
• Basel II capital reqirements could amplify boom-bust cycles:
• The present rules need to be reconsidered.