Global imbalances and the financial crisis

Sibert, Anne (2010) Global imbalances and the financial crisis. Other. The European Parliament, Brussels.

Abstract

Between 1997 and 2007 advanced economies ran large and growing current account deficits while developing economies ran large and growing current account surpluses. These imbalances were primarily due to low and falling saving-to-GDP ratios in the United States and large and rising saving-to-GDP ratios in China and the Middle East. Low and falling saving-to-GDP ratios in the United States were primarily, but not entirely, due to the distortions that caused high saving-to-GDP ratios in the developing world. These high savings led to higher equity prices in the United States until 2000 and lower real interest rates after that. Both higher equity prices and lower real interest rates lowered saving and helped fuel a housing boom in the United States. Monetary policy can lower the real interest rate in the short run, but cannot systematically affect real interest rates in the long run. Thus, monetary policy cannot be blamed for the rise in house prices in the United States. If there was a bubble component in the price rise, monetary policy was not the appropriate tool to deal with the problem. Capital flowed into the United States because the United States was a relatively attractive place to invest and because of the dollar’s status as the world’s premier reserve currency. The rise in US house prices helped cause the financial crisis by leading to financial firms’ securitisation of mortgages. This removed their incentives to screen and monitor their borrowers. US households became more leveraged and began to default when the housing boom finally ended. High degrees of leverage in the financial sector magnified the effect of changes in the prices of asset-backed securities on the balance sheets of financial firms. Factors leading to global imbalances were not the sole cause of the financial crisis. In the United States, regulators were lax in permitting unbridled securitisation. Especially in Europe, regulators were irresponsible to allow financial firms to become so leveraged. In the United States, lawmakers were culpable for permitting a patchwork institution-based regulatory system. Successive US presidents and the US Congress were to blame for misguided policies aimed at increasing home ownership. Global imbalances are caused by distortions, then fiscal and institutional changes should be used to correct them. The United States should phase out tax breaks to home owners in the form of mortgage interest deductions. The G-20 summit in Pittsburgh was of symbolic importance in that representatives from the developing world were included. The meeting was too large to be efficient, however.

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