John Cunliffe at the UK’s Bank of England has tried to sum up the impact of the global financial crisis in 2008-9 and what steps have been taken by monetary authorities globally since then to avoid another (http://www.bis.org/review/r150810c.htm).
In his speech to City of London types, Cunliffe starts by remembering that Roman Emperor Tiberius adopted similar monetary easing measures back in 33 AD when there was a similar financial crash. This was also the year of ‘Our Lord’ being crucified and resurrected (according to gospel legend).
Cunliffe is not fully convinced that the global financial system of 2015 has been fully resurrected though. He points out that following each previous financial crisis, steps were taken to avoid another, but each time the financial sector slipped back into its ‘old ways’.
In the credit bubble that began back in 1997 (a reaction, in my view, to falling profitability in the productive sectors of the UK economy), “the stock of domestic lending by UK banks in the UK grew enormously from 95% in 1997 to 170% of GDP in 2008. The stock of non-property lending to companies as a proportion of GDP, however, grew only modestly from 19% in 1997 to 23% in 2008. Meanwhile, mortgage lending increased from 45% to 70% of GDP; lending to real estate tripled from 5% to 15% of GDP; and lending to the UK non-bank financial sector – including institutions like hedge funds, securities dealers and insurance companies – shot up from 25% of GDP to 60%. And these numbers do not count the explosion in UK-owned banks’ overseas exposures which more than quadrupled between the end of the 1990s and 2008.”
Cunliffe goes on: “Nor did this increase in lending drive a commensurate increase in economic growth in this particular credit cycle. Over the period 2000-2007 GDP growth averaged little more than its long-run average of around 2.8%. In fact, business investment over the period averaged just 1.3% a year and it appears that most of this was related to commercial real estate.”
He concludes that: “In other words the massive increase in the stock of lending – an increase of £1.7 trillion in absolute terms – did not lead to very much of an increase in productive investment at all.”
And Cunliffe summed up the damage that the last global financial crash caused to the UK economy, among others. “Seven years on and output per person has only just reached its pre-crisis level. We have not even recovered the pre-crisis rate of annual growth in productivity of around 2.3% and the level of productivity of our economy is around 15% lower than it would have been on pre-crisis trends. There is now a growing body of evidence on the very damaging impact of financial crises on the productive capacity of economies.”
This is not good, says Cunliffe, “Strong sustainable growth requires not only a strong and vibrant financial system; it requires the controls and safety buffers to ensure that the dynamics of the system do not generate periods of illusory growth and prosperity followed by periods of destruction of the same.”
So since 2008, have global monetary authorities got their act together? Well, Cunliffe reckons that “the financial system has come a long way since the time of Emperor Tiberius. While we have relearned some familiar lessons in recent years, we have also learned some new ones. We have had to develop a new regulatory framework, macroprudential institutions like the FPC and new policy approaches.”
So things are better and we have gone from the crucifixion of the real economy to resurrection? He still sounded unsure. “The implementation of the detailed reforms will inevitably throw up unforeseen effects in particular places and where it is justified we will need to revisit issues. But we should be careful about talking about turning back the overall regulatory dial or trying to trade off the risk of financial instability for short term growth.”
Indeed, “macroprudential policy is still a work in development. Over the past few years much of the FPC’s work has been learning by doing. As we learn, we will have to set out clearly and publicly the development of our overall policy framework – how resilient we believe the system needs to be, how we think about macroprudential risk, what risks we believe fall into the domain of macroprudential and how we will use our policy instruments.”
So next time will be different? We need more research…