The Ties That Bond Us: What Demand For Government Debt Can Tell Us About the Risks Ahead


by Serkan Arslanalp and Takahiro Tsuda

It’s not news that emerging markets can be vulnerable to bouts of market volatility. Investors often pull sudden stops—they stop buying or start selling off their holdings of government bonds.

But what has become apparent in recent years is that advanced economy government bond markets can also experience investor outflows, and associated runs. At the same time, some traditional and new safe haven countries have seen their borrowing costs drop to historic lows as they experience rising inflows from foreign investors.

Our new research shows that advanced economies’ exposure to refinancing risk and changes in government borrowing costs depend mainly on who is holding the bonds— the demand side for government debt.

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Time Not On Our Side: Tough Decisions Needed to Strengthen Financial Stability


By José Viñals

(Versions in  عربي中文EspañolFrançaisРусский日本語)

Recent policy actions in Europe, the United States, in emerging markets, and here in Japan, where I’m attending the IMF-World Bank annual meetings, have improved investor sentiment and helped markets rebound in recent months.

Yet our latest assessment is that confidence is still very fragile and risks have increased, when compared to the IMF’s last report in April. Policymakers need to do more to gain lasting stability.

The principal risk remains the euro area. The forces of financial and economic fragmentation have widened the divide between countries at the core and the “periphery” of the euro zone. Faltering confidence and policy uncertainty have led to a pullback of cross-border private capital flows from the periphery—quite an extraordinary phenomenon within a currency union.

This has driven up funding costs to governments and banks, as well as for companies and households, and, in turn, threatening a vicious downward economic spiral.

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Not Making the Grade: Report Card on Global Financial Reform


by Laura Kodres

Despite a host of reforms in the right direction, the financial structures that were in place before the global crisis have not actually changed that much, and they need to if the global financial system is to become a safer place.

Although the intentions of policymakers are clear and positive, the system remains precarious.

Our new study presents an interim report card on progress toward a safer financial system. Overall, there is still a long way to go.

How we measure progress

In our study, we first tried to pay attention to those features of financial systems related to the crisis—the large dominant, highly interconnected institutions, the heavy role of nonbanks, and the development of complex financial products for instance—features that need to be addressed in some way.

To do this we needed to construct measures of these features in a way that would allow us to gauge how well the reforms are working toward changing them. We looked at a lot of data, but we focus on three types of features.

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The Long-term Price of Financial Reform


by André Oliveira Santos and Douglas J. Elliott

In response to the global crisis, policymakers around the world are instituting the broadest reform of financial regulation since the Great Depression.

Some in the financial industry claim the long-run economic costs of these global reforms outweigh the benefits. But our new research strongly suggests the opposite—the reforms are well worth the money.

Granted, just as adding fenders, safety belts, airbags, and crash avoidance features can make cars slower, we know that additional safety measures can slow down the economy in years when there is no crisis. The payoff comes from averting or minimizing a disaster.

Five years after the onset of the current crisis, we sadly know all too well the cost in terms of economic growth, so the potential gains in avoiding future crises are very large.

Our study finds that the likely long-term increase in credit costs for borrowers is about one quarter of a percentage point in the United States and lower elsewhere. This is roughly the size of one small move by the Federal Reserve or other central banks. A move of that size rarely has much effect on a national economy, suggesting relatively small economic costs from these reforms.

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Japan Stands Up


By Jerry Schiff

(Version in  日本語)

As a Japanese proverb has it: “Knocked down seven times, get up eight.”

In a display of its resilience, Japan is getting up once again after the devastating earthquake and tsunami of a year ago.  But the world’s third largest economy still faces multiple challenges, and in our latest assessment of the country’s economy, the Japanese mission team at the International Monetary Fund has proposed a range of mutually reinforcing policies to strengthen confidence, raise growth and help restore Japan’s economic vitality.

A year and four months ago, Japan was reeling from the Great East Japan earthquake and accompanying devastation.  As well as the tragic loss of life, the economy was badly shaken.  Supply chain disruptions brought production in parts of Japan to a virtual halt. Yet, since then, the country has shown its resilience, with reconstruction contributing to strong first quarter growth of 4¾ percent.

But despite this hopeful sign, all is not well.

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Mind The Gap: Policies To Jump Start Growth in the U.K.


By Ajai Chopra

The U.K. economy has been flat for nearly two years. This stagnation has left output per capita a staggering 14 percent below its precrisis trend and 6 percent below its pre-crisis level.

Weak growth has kept unemployment high at 8.1 percent, with youth unemployment an alarming 22 percent.

The effects of a persistently weak economy and high long-term unemployment can reverberate through a country’s economy long into the future—commonly referred to by economists as hysteresis.

Our analysis of such hysteresis effects shows that the large and sustained output gap, the difference between what an economy could produce and what it is producing, raises the danger that a downturn reduces the economy’s productive capacity and permanently depresses potential GDP. 

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Risks to Financial Stability Increase, Bold Action Needed


By José Viñals

(Versions in  عربي中文EspañolFrançaisРусский日本語)

Our latest update of the Global Financial Stability Report has three key messages.

First, financial stability risks have increased, because of escalating funding and market pressures and a weak growth outlook.

Second, the measures agreed at the recent European leaders’ summit provide significant steps to address the immediate crisis, but more is needed. Timely implementation and further progress on banking and fiscal unions must be a priority.

And third, time is running out. Now is the moment for strong political leadership, because tough decisions will need to be made to restore confidence and ensure lasting financial stability in both advanced and emerging economies. It is time for action.

Now, why have financial stability risks increased?

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World Faces Weak Economic Recovery


By Olivier Blanchard

(Versions in  عربي中文EspañolFrançaisРусский日本語)

The global recovery continues, but the recovery is weak; indeed a bit weaker than we forecast in April.

In the Euro zone, growth is close to zero, reflecting positive but low growth in the core countries, and negative growth in most periphery countries.  In the United States, growth is positive, but too low to make a serious dent to unemployment.

Growth has also slowed in major emerging economies, from China to India and Brazil.

Downside risks, coming primarily from Europe, have increased.

Let me develop these themes in turn.

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Lost & Found in Eastern Europe: Replacing Funding by Western Europe’s Banks


By Bas Bakker and Christoph Klingen

With Western Europe’s banks under pressure, where does this leave Europe’s emerging economies and their financial systems that are dominated by subsidiaries of these very same banks?  There is little doubt that the era of generous parent-funding for subsidiaries is over.  But parent bank deleveraging—selling off assets, raising capital, and reducing loans, including to their subsidiaries—need not translate into a reduction of bank credit in emerging Europe.

A credit crunch can be avoided as long as parent banks reduce exposures gradually and domestic deposits, other banks, and local financial markets fill the void. Policymakers should create the conditions for this to happen.

The ties that bind

The dependence of the banking systems in emerging Europe on Western European banks is well known:

  • Ownership— foreign banks control more than half of the banking systems in most of Central, Eastern, and Southeastern Europe. Their share exceeds 80 percent in Bosnia, the Czech Republic, Croatia, Estonia, Romania, and Slovakia. Only in Russia, Ukraine, Belarus, Moldova, Slovenia, and Turkey do they not dominate.

Imagining If Key Foreign Banks Start Reducing Their Exposure in Asia


By Anoop Singh

European banks play an important role in supplying credit to several Asian economies. What happens if they start reducing their exposure to the region?

The largest borrowers from European banks are Australia, Hong Kong SAR, Korea, Malaysia, New Zealand, Singapore, and Taiwan Province of China, while China, India, and the economies of South East Asia generally have smaller liabilities.

Among European banks, those from the United Kingdom have a particularly significant presence in Asia. For most regional economies, the nonbank private sector—businesses and households—is the main recipient of credit from foreign banks as a whole.

Prominent role

European banks play a prominent role in the areas of trade credit and specialized project financing. In several Asian economies, however, lending by local subsidiaries and branches is funded primarily by local deposits, reducing potential deleveraging pressures.

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