Current situation and forecast.

Case:
Comparison of the Covid crisis
and the financial crisis
Outline

I. Financial crisis

1. The start and origin of the last financial crisis

II. Financial crisis vs Covid

2. Effects: Covid crisis and Financial crisis

3. Forecast (what now?)

1. The origins of the financial crisis
1. The origins of the financial crisis
The real estate bubble in the U.S (subprime mortgage crisis in 2006)

Source: S&P Dow Jones Indices.

Accelerated pace of “Bubble

home price increases burst”

Note: The S&P CoreLogic Case-Shiller Home Price Indices are the leading measures of U.S. residential real estate prices,
tracking changes in the value of residential real estate both nationally as well as in 20 metropolitan regions ( link)
1. The origins of the financial crisis

Main causes of the bubble:

1. The low interest rate regime (as allowed by the FED).

2. Huge savings from China and other Asian countries (long term financing at low interest
rates)

3. The gradual advance of the U.S economy after the brief recession in 2001.

4. “Self-fulfilling expectations” (the bubble magnifies as speculation increases).

Because Banks were sure home mortgages were sound collateral for mortgage backed
securities, banks and other institutions invested heavily in derivatives of these products.
High demand for these derivatives made Banks offer them to even subprime borrowers

5. Clinton administration + Republican congress: repeal of the Glass-Steagall act (end of banks
regulation); Commodity Futures Modernization Act (exempted swaps and derivatives from some
regulation and oversight); Community Reinvestment Act (to encourage banks to lend in low-income
neighborhoods).
1. The origins of the financial crisis

The bubble burst led to a financial crisis, where the financial system
stopped acting as an efficient mechanism to allocate resources. This
caused:

1. Significant asset prices decrease.

Stock market crash in 2008. The Dow saw one of the largest point
drops in its history.

2. Financial and non-financial bankruptcies.

- Banks and other financial institutions found themselves holding
worthless investments.
- “Too big to fail”
- Lehman Brothers declared bankruptcy (Sept 15th 2008).

3. Increased uncertainty and difficulties in obtaining financing.

1. The origins of the financial crisis

The crisis aggravated the assymetric information problems of

the financial system:

1. The financial intermediaries (banks, leasing entities, etc.)

usually alleviate assymetric information through their
knowledge, experience, specialization and reputation.

2. As a financial crisis advances, confidence on these

intermediaries deteriorates, worsening the crisis.
1. The origins of the financial crisis

The financial crisis that originated in the U.S. affected the real
economy of Europe and of other regions through several channels:

1. The economic crisis in United States caused a decrease in X-M and a

collapse in international trade

2. European exposure to “toxic assets”: loss of asset value and

subsequent poverty effects

3. Loss of confidence in financial markets, which resulted in severe

liquidity restrictions.

4. Severe decrease in domestic aggregate demand

2. The crisis transmission

Before the crisis….

9
GDP growth – a rescaled visual picture
GDP growth – a rescaled visual picture
GDP growth – a rescaled visual picture

2009
 Real GDP Growth 2009.
Source: World Economic Outlook. October 2013. IMF Data Mapper.
Source: Real GDP Growth 2021. IMF Data Mapper.
2. Effects: financial crisis

The impact of the financial crisis varied for each country and
depends on a country’s strengths and weaknesses and previous
conditions:

1. The existence of real estate and financial bubbles: Over-

indebtness.

2. The sectoral composition of output and employment: the weight

of the construction sector.
3. The external position of the economy: debt holders vs credit
holders.
4. Market rigidities: shock absorption capabilities.

5. Existing fiscal policy and its limits.

Financial crisis vs covid crisis
• Similarities: Uncertainty

https://policyuncertainty.com/
Financial crisis vs covid crisis
• Similarities: Magnitude of effects
* Gross domestic product, constant prices (real growth), percent change.

Source: Real GDP Growth 2021. IMF Data Mapper.

Financial crisis vs covid crisis
• Differences: different transmission mechanisms

• Covid: first large supply component, which then results in contraction in

demand
• Highly integrated supply chains, physical lockdowns
• Then quickly spread to the rest of the economy

• Financial crisis: first large demand component, which then results in

contraction in supply
• Subprime crisis, which resulted in poverty effects
• Contraction of aggregate demand
Financial crisis vs covid crisis
• Differences: different recovery paths

• Much faster recovery is expected for Covid

https://voxeu.org/article/tale-three-depressions
Financial crisis vs covid crisis
• Similar but different: although very strong, policy responses have
been diffferent

https://voxeu.org/article/tale-three-depressions
Financial crisis vs covid crisis
• Similar but different: fiscal policy

https://www.ecb.europa.eu/pub/economic-bulletin/articles/2021/html/ecb.ebart202101_03~c5595cd291.en.html
Financial crisis vs covid crisis
• Similar but different: monetary policy
Financial crisis vs covid crisis
• Similar but different: monetary policy

https://www.bis.org/publ/work934.htm
2. Financial crisis vs covid crisis
Let´s compare the effects on:
• Production
- GDP growth
- PMI (Purchasing Managers Index)

• Unemployment

• Current account balances

• Trade
2. Effects: GPD growth 1/4

World recession: Large decline in global GDP growth rates

* Gross domestic product, constant prices (real growth), percent change.

Source: Real GDP Growth 2021. IMF Data Mapper.

2. Effects 2/4

World recession, but especially bad in advanced economies

* Gross domestic product, constant prices (real growth), percent change.

Source: Real GDP Growth 2021. IMF Data Mapper.

2. Effects 4/4

World recession, but geographic differences

* Gross domestic product, constant prices (real growth), percent change.

Source: Real GDP Growth 2021. IMF Data Mapper.

2. Effects 1/4

Severe decline in industrial production

Fuente: World Economic Outlook. Abril 2009, p. 4.

2. Effects 2/4

The Purchasing Managers'

Index (PMI) is an index of the
current direction of economic
trends in the manufacturing
sector. It captures whether market
conditions are expanding
(PMI>50) or contracting
(PMI<50). It´s constructed using
monthly survey responses from
supply chain managers of 19
industries.

https://ihsmarkit.com/research-analysis/02112017-Economics-Global-
manufacturing-PMI-hits-highest-since-April-2011.html
2. Effects 3/4

Severe decline in industrial production

Both crises result in severely worsening conditions in the manufacturing sector. In Covid we
see a large effect of supply chain issues, which increase input costs and create uncertainty

https://ihsmarkit.com/research-analysis/02112017-Economics-Global-manufacturing-PMI-hits-highest-since-April-2011.html

https://www.markiteconomics.com/Public/Home/PressRelease/f412be3b367347ffb3f63f2d0c8ca69c
2. Effects 4/4

During the Covid crisis,

GDP changes were
determined by the
collapse in C.

The service sector was

more affected than
manufacturing.
2. Effects: Unemployment 1/4

Large effects on unemployment

Source : IMF. World Economic Outlook. Octubre 2010, p. 11

2. Effects 2/4

Effects on unemployment

Source : FMI. World Economic Outlook. October 2016, p. 12.

2. Effects 3/4

Effects on unemployment

The financial crisis

created large
unemployment effects

The Covid crisis also

created imbalances,
largely due to partial or
complete shutdowns

Source: World Bank. Unemployment 1991-2021.

2. Effects 4/4

Effects on unemployment

2009 Today

Source: World Bank. Unemployment

2. Effects: current account balances 1/1

Big imbalances in current account balances

The financial crisis created

large imbalances in current
accounts

The Covid crisis also created

imbalances, but much smaller
and easier to finance due to
financial support. Imbalances
are not predicted to last.

https://blogs.imf.org/2021/08/02/how-the-pandemic-widened-global-current-account-balances/
2. Effects: trade 1/3

Reduction in international trade

Source: World Trade Report 2015, p. 14.

https://www.wto.org/english/res_e/statis_e/trade_e
volution_e/evolution_trade_wto_e.htm
2. Effects 2/3

Why such a reduction in international trade?

1. Dependence on financing.
2. Global supply chains and distribution.
3. Simultaneous fall in aggregate demand in multiple world zones.
4. Composition of the fall in aggregate demand:
• Fall in the consumption of durable goods and business
investment.
• Both are important components of trade in GDP.
2. Effects 3/3

Trade was already

slowing in 2019 before
Covid, due to trade
tensions and slowing
economic growth

“The fall in trade we

are now seeing is
historically large – in
fact, it would be the
steepest on record. But
there is an important
silver lining here: it
could have been much
worse” (Roberto
Azevêdo, WTO
Director General)

https://www.wto.org/english/news_e/pres20_e/pr858_e.htm
What
now?
  Economies in Recession (1871-2020): A Record High
Number

Source: World Bank (June 2020).). 

Where are we at?
Where are we at?

Additional Poor at the US$1.90-a-Day Line in 2020 per Covid-19 (millions of persons)
 

 Source: World Bank, Poverty and Shared Prosperity 2020, Reversals of Fortune,  (October 2020).
Where are we at?

Source: https://www.unocha.org/global-humanitarian-overview-2021
Where are we at?

Source: https://www.unocha.org/global-humanitarian-overview-2021
Where are we at?
What´s the outlook like?
What´s the outlook like?
What´s the outlook like?

Economic prospects have diverged further across countries

since the April 2021 World Economic Outlook (WEO) forecast. Vaccine access
has emerged as the principal fault line along which the global recovery
splits into two blocs: those that can look forward to further normalization of
activity later this year (almost all advanced economies) and those that will still
face resurgent infections and rising COVID death tolls. The recovery, however, is
not assured even in countries where infections are currently very low so long as
the virus circulates elsewhere.
What´s the outlook like?

Inflation is expected to return to its pre-pandemic ranges

in most countries in 2022 once these disturbances work their way
through prices, though uncertainty remains high. 

Central banks should generally look through transitory inflation pressures and avoid
tightening until there is more clarity on underlying price dynamics. Clear
communication from central banks on the outlook for monetary policy will be key to
shaping inflation expectations and safeguarding against premature tightening of
financial conditions.
What´s the outlook like?

Financial conditions could tighten rapidly, for instance from a

reassessment of the monetary policy outlook in advanced economies if inflation
expectations increase more rapidly than anticipated. A double hit to emerging
market and developing economies from worsening pandemic dynamics and tighter
external financial conditions would severely set back their recovery and drag global
growth below this outlook’s baseline