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22. Is the recovery sustainable in the US and Europe?
- Publication Date:
- 02-2010
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- Following the worst recession since the 1930s, the US, UK and Eurozone economies have all now returned to positive growth. With the boost from policy stimulus and the inventory cycle peaking, however, this raises questions about the sustainability of the current rebound. The analysis presented here suggests that the recoveries in both the US and Europe will be relatively muted compared to recent historical experience. The US is likely to be the growth leader, reflecting the more dynamic nature of its economy and financial sector. A key uncertainty relates to how labour markets will perform during the recovery phase. To date, the rise in US unemployment been particularly severe when compared to the experience of Europe. In light of the sharp falls in European productivity, we expect employment gains in Europe to be more muted in the recovery phase than in the US. The performance of residential real estate markets also remains important. Home prices in the US are now close to fair value by most metrics, suggesting that the correction in prices is likely to be bottoming out. In Europe, only Spain and Ireland appear to be in the midst of substantial housing market corrections. Commercial real estate markets are also facing ongoing corrections in many countries. While conditions in the US and Eurozone may deteriorate further, commercial property values appear to be stabilising in the UK following earlier sharp declines. The ability of the banking sector to finance the economic recoveries in the US and Europe remains a key risk to the growth outlook. As the process of absorbing credit losses and rebuilding capital is likely to be protracted, the normalisation of lending standards is likely to take longer than following recent recessions. This is a particular concern for the Eurozone, where bank funding is more important for companies. Whether domestic demand in the US and Europe recovers will also depend on whether private sector deleveraging has further to run. The destruction of household net wealth in the US suggests that the personal savings rate has further to rise, whereas there no longer appears to be a pressing need for households in the UK and Eurozone to consolidate their balance sheets. In contrast, non-financial corporations in the US are in a stronger financial position than their European peers, having not increased debt levels as rapidly during the credit boom. Risks around public finances have received the most attention in recent weeks. In particular, the adjustments underway in Greece pose a risk of potential contagion from sovereign credit risk that could threaten growth on both sides of the Atlantic.
- Topic:
- Economics, Markets, and Financial Crisis
- Political Geography:
- United States, United Kingdom, and Europe
23. Is Greece heading for default?
- Publication Date:
- 02-2010
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- Greece has slid into a serious fiscal crisis over the last few months. A ballooning budget deficit and high levels of government debt have raised questions in the minds of investors about the sustainability of the country's public finances. The level of concern among investors can be seen from developments in Greek borrowing costs relative to those in Germany. At the beginning of 2008, the yield on Greek 10-year bonds was only around 0.3% higher than on equivalent German securities, but this gap has now risen to over 3%. This yield spread is at its widest for more than a decade and is by far the largest within the Eurozone. The root cause of Greece's problems is a long period of fiscal indiscipline. In 2009, after years of heavy spending, the budget deficit rose to almost 13% of GDP and the public debt to GDP ratio is set to reach 125% this year. The deteriorating fiscal position has led to a slew of ratings downgrades, and outside the Eurozone Greece's credit rating would probably be in 'junk' territory. On top of the fiscal problems, Greece also suffers from weak external competitiveness. The real exchange rate has appreciated substantially since Greece joined the Eurozone, contributing to a sharp widening in the current account deficit to around 12% of GDP last year. On some estimates, the real effective exchange rate is now around 20% overvalued. As a result Greece now faces a series of policy choices all of which look unpalatable. Within the Eurozone, the only realistic orthodox option is a combination of massive fiscal retrenchment and 'internal devaluation' – forcing down costs relative to those of Greece's competitors. But fiscal cutbacks and cost deflation on the scale required could plunge the country into a deep and prolonged recession and might prove politically and socially unsustainable. The Greek economy is already showing signs of serious stress, with GDP down 2.6% on the year in 2009Q4. The extreme alternatives are default and/or leaving the Eurozone and enacting devaluation. But the political barriers to such moves are immense, and while default and devaluation could ease budgetary and external imbalance problems, they would also cause massive economic and financial disruption and probably a deeper recession in the near-term. Default and devaluation would also risk huge negative contagion effects on the Eurozone and the wider global economy. With Greece's debt approaching €300 billion a default would be the largest sovereign collapse since WWII, dwarfing those in Russia and Argentina. Eurozone banks could face losses of up to €100 billion on top of the heavy writedowns already suffered, risking a renewed Europe-wide credit squeeze. There could also be collapses in demand for the debt of other weaker Eurozone members such as Spain, Portugal and Ireland. World markets for equities, corporate bonds and emerging market debt would also likely be badly affected. There could also be pressure for the major economies to accelerate their fiscal adjustment efforts, given the impact on investor confidence and the scale of their budget deficits. Our estimation results suggest that a Greek default could be a real threat to the progress of the global recovery, cutting growth in the major economies by around 1% per annum compared to our baseline forecast and world growth by 0.6%. Given the potential massive consequences of a Greek default, the pressure for a bailout has been growing. Although there are questions about the legality of such a move, we believe it is possible if the political will exists. Estimation results using the Oxford Model suggest a bailout would be likely to be less economically damaging than a default, even assuming some negative impact from higher bond yields in the core Eurozone countries. The costs of a bailout could rise rapidly, however, if it extended beyond Greece to other troubled countries. A bailout would create a big risk of moral hazard, perhaps inducing fiscal misbehaviour among other Eurozone members or being used by Greece to sidestep the necessary adjustment. To avoid this, any bailout would have to incorporate strict conditionality, perhaps raising serious questions about fiscal sovereignty within the Eurozone. Over the last two weeks, the other EU countries have taken a relatively hard line with Greece, stopping short of announcing explicit financial support and pushing for strong fiscal adjustment measures. Although a bailout remains the most likely outcome if Greece struggles to refinance its debts, there are some signs that political resistance to such a move is growing. The key risk period could be April-May, when a large volume of Greek debt matures.
- Topic:
- Economics, Markets, and Financial Crisis
- Political Geography:
- Europe, Greece, and Argentina
24. Credit Crunch Watch
- Publication Date:
- 10-2009
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- The financial stress indicator is a composite index of a number of indicators including risk spreads, mortgage spreads, equity volatility, commercial paper and commercial loans outstanding and the spread of LIBOR rates over T-bill rates (the “Ted” spread). The stress indicator fell again last week, driven by a further narrowing of corporate bond spreads and lower equity volatility. These shifts offset a rise in 30-year mortgage spreads. Stress levels are now at their lowest levels since February 2008, and while still well above their long-term average have also dropped below the levels seen in previous periods of distress such as in the early 1990s and in 2001- 2003.
- Topic:
- Economics, Markets, and Financial Crisis
- Political Geography:
- United States
25. Financial meltdown averted – but how deep and how widespread will the recession be?
- Publication Date:
- 01-2009
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- The credit crunch that began in July 2007 intensified dramatically in September 2008, with a series of bank failures prompting rescues and effective nationalisation of major financial institutions in the US, the UK and the Eurozone. Despite massive intervention, financial stress rose to new highs at the start of Q4 2008 as financial markets dried up, with treasury bond yields falling, interbank lending rates still high, emerging market spreads widening sharply and stock markets plunging further. Faced with financial sector meltdown, many governments have recapitalised banking sectors and guaranteed interbank loans and bank deposits to try to shore up confidence in the financial system. These moves have averted a meltdown, but the spotlight has moved onto the rapidly weakening real economy – both world growth and world trade are now expected to decline in 2009, making it the worst year since 1945.
- Topic:
- Economics, Markets, and Financial Crisis
- Political Geography:
- United States
26. Global capital flows on the rebound?
- Publication Date:
- 10-2009
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- Global capital flows dropped steeply in the wake of the financial crisis, with an unprecedented outflow of foreign funds both from developed and emerging markets.
- Topic:
- Economics, Globalization, Markets, and Monetary Policy
27. Leaders and laggards, on the way down and up
- Publication Date:
- 10-2009
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- With the economies of most countries having passed their troughs, it is a good time to take stock of some of the main features of the crisis so far and to assess what the upturn may look like. In this article, we look back at how the different countries have fared in this crisis and how monetary and fiscal authorities have responded to the crisis. We then turn to the nascent recovery to compare and contrast the upturn across countries. Finally, we highlight some of the main legacies of this crisis. Exposure to financial services, housing booms, consumer debt and trade with the US were seen as factors that would make some countries suffer deeper downturns than others. In the event, the downturn has surprised by how quickly it has spread across countries. So the most affected countries turned out to be the most exposed to the world economy such as Germany, Italy, Japan and Eastern Europe. All major central banks have responded with aggressive cuts in interest rates and adopted wide-ranging unconventional measures. This has helped stabilise financial markets, but the goal of getting credit flowing to the non-financial economy has not yet been achieved. Governments have also responded to the crisis with large fiscal stimulus packages. These packages have helped contain the collapse in activity and contributed to some countries exiting the recession in 2009Q2. Whether these packages will be enough to get the world economy back on a sustainable growth path is still uncertain though. Beyond the short term, where fiscal stimulus and the stock cycle will boost growth, the recovery is expected to be sluggish and bumpy in most places. History suggests that recoveries from financial crises tend to be slower than others, and the repair of household and corporate balance sheets will be a drawn out process. In addition, with large amounts of spare capacity around the world, demand for investment will be weak for some time to come. Furthermore, the nascent upturn has already put pressure on oil and commodity prices. If this continues, it will hamper growth in net importer economies. These factors will combine with country-specific features that determine their potential growth. We forecast the recovery to be most drawn out in Italy, Japan and Germany as these countries are hit by weak demand for investment goods and are characterised by relatively low potential growth. One main legacy of this crisis is the likelihoo d of years of fiscal austerity, to bring public deficits back under control. Another legacy may be in changes to the regulation of financial services, although do date little progress has been made in this area. In addition, EMU has so far proved a resilient entity during the crisis, so that the euro could gain a more prominent role on the world stage, depending on how it fares in the upturn.
- Topic:
- Economics, Globalization, and Markets
- Political Geography:
- Japan, Europe, Germany, and Italy
28. Why are US home foreclosures so high?
- Publication Date:
- 06-2009
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- US mortgage foreclosures have risen to extraordinary heights in recent months, with the scale of the distress in the US mortgage market much greater than in the UK. Key factors behind this divergent performance include laxer underwriting standards in the US and the widespread existence of 'non-recourse' loans. The latter allow borrowers in negative equity to walk away from their mortgage debt and sap the incentive to remain current on 'underwater' loans. As a result, steep house price falls can generate a sharp rise in foreclosures even without high interest rates or unemployment. In the UK, by contrast, there are strong incentives for home owners to remain in their properties, even when in negative equity.As a result, the escalation from arrears to foreclosure in the UK is much more limited. This may head off very abrupt prices falls but could also mean a more drawn out process of adjustment in the housing market.
- Topic:
- Debt, Economics, Markets, and Financial Crisis
- Political Geography:
- United States
29. Slump in wealth to hinder global recovery prospects?
- Publication Date:
- 05-2009
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- Since the credit crunch began in Q3 2007, there has been a dramatic slump in the prices of many financial assets. Global equity prices have dropped some 40-50% from their peaks in the major economies and by as much as 70% in some emerging markets. Many classes of other private sector securities have also seen sharp falls in value. Corporate bond spreads have exploded as defaults have soared, as have mortgage-backed securities (MBS). Currently, many classes of MBSs are trading at less than 10% of their par value, and even AAA-rated tranches are trading at as little of 25% of par.
- Topic:
- Economics, Markets, and Financial Crisis
- Political Geography:
- United States
30. How far away is a global recovery?
- Publication Date:
- 03-2009
- Content Type:
- Working Paper
- Institution:
- Oxford Economics
- Abstract:
- Steep drops in output have been recorded across the industrialised world and much of the emerging market world in recent months. Such has been the scale of these declines that there is now little doubt that the global economy is set for its worst year since the end of WWII, with world GDP forecast to fall almost 1½% (and more than 2% at 2000US$). Significant uncertainties nevertheless remain about the economic outlook, in particular about how deep and protracted the recession will prove to be and how rapid an eventual recovery can be expected. A key factor generating uncertainty is that the current recession has been sparked by and accompanied by a major financial crisis. Recessions of this sort are often more severe than 'standard' recessions, featuring deeper and more sustained drops in asset prices, and a weaker impact from policy interventions due to malfunctioning banking systems. Equity and house prices have continued to drop in the early part of 2009, and there looks to be a significant risk that this weakness will drag on for some time – the average duration of stock price declines in previous financial crises is more than three years and for house prices around six years. The financial sector also remains in a highly dysfunctional state. Although the credit tightening process is showing some signs of coming to an end, stress levels remain extremely elevated and risk appetite is low with banks stuck in 'balance sheet repair mode'. This process is unlikely to be complete for some time. Retrenchment has also become a priority for the corporate and household sectors. In the face of a plunge in final demand, firms have slashed investment and begun destocking. Worryingly, the destocking process could continue f or several quarters as the ratio of inventory to sales remains high. US households were net re payers of debt in the final quarter of 2008, and it seems unlikely that the appetite to take on more debt will recover quickly there or elsewhere in the face of steep increases in unemployment and large falls in household wealth. Taylor rule analysis suggests that the 'appropriate' short-term interest rate for the major economies has now turned negative, supporting the big shift to quantitative easing now under way. Eventually, this and other stimuli in the pipeline should produce a strong recovery. But the outlook for 2010 has weakened significantly in recent weeks and the risks remain skewed toward a more deflationary outcome than that envisaged by our baseline forecast.
- Topic:
- Economics, Markets, Foreign Direct Investment, and Financial Crisis
- Political Geography:
- United States
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