W O R K I N G

P A P E R S

I N T E R N A T I O N A L
N o v e m b e r

2 0 0 9

I N

E C O N O M I C S

N o .

2 . 0 9

The Global Financial Crisis:

Causes and Consequences

Warwick J McKibbin and

Andrew Stoeckel

I n t e r n a t i o n a l

E c o n o m y

P r o g r a m

TheLowyInstituteforInternationalPolicy is an independent internationalpolicy

thinktank. Itsmandaterangesacrossallthedimensionsofinternationalpolicydebate
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This Working Paper series presents papers in a preliminary form and serves to
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authors ownandnotthose oftheLowyInstituteforInternationalPolicy.

TheGlobalFinancialCrisis:CausesandConsequences*
WarwickJ.McKibbin**
CAMA,AustralianNationalUniversity &
TheBrookingsInstitution
AndrewStoeckel
VisitingFellow,CAMA
AustralianNationalUniversity

RevisedSeptember2009

JELClassifications:.
Keywords:GlobalFinancialCrisis,InternationalTrade,DSGEmodels.

* Preparedforthe AsianEconomicPanelmeetingtobe heldinTokyo,September.WethankPeterDownes,Vivek

Tulpuleforuseful conversationsandWillMartin, JeanPierreChauffour,YonghyupOh,AnwarNasution,Mark
Thirlwell andparticipantsattheAsianEconomicPanel forcomments. McKibbinacknowledgessupportfromARC
DiscoveryGrantDP0664024. Theviewsexpressedinthepaperarethoseoftheauthorsandshouldnotbeinterpretedas
reflectingtheviewsofanyoftheabovecollaboratorsoroftheInstitutionswithwhichtheauthorsareaffiliatedincluding
thetrustees,officersorotherstaffoftheANUorTheBrookingsInstitution.
** Sendcorrespondenceto ProfessorWarwickJMcKibbin, CentreforAppliedMacroeconomicAnalysis,ANUCollegeof
BusinessandEconomics,AustralianNationalUniversity,ACT0200,Australia.Tel: 61261250301,Fax: 612
61253700,Email: warwick.mckibbin@anu.edu.au.

TheGlobalFinancialCrisis:CausesandConsequences
Abstract

Thispapermodelstheglobalfinancialcrisisasacombinationofshockstoglobalhousing
marketsandsharpincreasesinriskpremiaoffirms,householdsandinternationalinvestorsin
anintertemporal(orDSGE)globalmodel.Themodelhassixsectorsofproductionandtrade
in15majoreconomiesandregions.Thepapershowsthattheshocksobservedinfinancial
marketscanbeusedtogeneratethesevereeconomiccontractioninglobaltradeand
productioncurrentlybeingexperiencedin2009.Inparticularthedistinctionbetweenthe
productionandtradeofdurableandnondurablegoodsplaysakey roleinexplainingthe
muchlargercontractionintradethanGDPexperiencedbymosteconomies.
Theresultsshowthatthefutureoftheglobaleconomydependscriticallyonwhetherthe
shockstoriskareexpectedtobepermanentortemporary.

WarwickMcKibbin
CentreforAppliedMacroeconomicAnalysis
CollegeofBusinessandEconomics
AustralianNationalUniversity
&TheBrookingsInstitution
Washington DC

AndrewStoeckel
CentreforAppliedMacroeconomicAnalysis
CollegeofBusinessandEconomics
AustralianNationalUniversity

1
1.Introduction
ThecollapseofLehmanBrothersinSeptember2008,sentawaveoffeararoundworld
financialmarkets.Banksvirtuallystoppedlendingtoeachother.Theriskpremiumon
interbankborrowingrosesharply to5percent,whereastypicallyitwasclosetozero.
Althoughauthoritiesscrambledtoinjectliquidityintofinancialmarkets,thedamagewas
done.Theriskpremiumoncorporatebondsshotupevenmoretoover6percent.Large
CAPEXprojectswereshelved,thecorporatesectorvirtuallystoppedborrowing,tradecredit
washardtogetand,withfallingdemand,particularlyforinvestmentgoodsand
manufacturingdurableslikecars,tradevolumescollapsed.
Theresultisthattheglobalfinancialcrisishasseenthelargestandsharpestdropinglobal
economicactivityofthemodernera.In2009,mostmajordevelopedeconomiesfind
themselvesinadeeprecession.Thefalloutforglobaltrade,bothforvolumesandthepattern
of tradehasbeendramatic. TheOECDpredictsworldtradevolumescouldshrinkby13
percentin2009from2008levels.1
Governmentshaverespondedwithaneasingofmonetaryandfiscalpolicythatinturnhave
theirowneffectsonactivityandfinancialandtradeflows.Thedownturninactivityis
causingunemploymenttorisesharplyand,withit,apoliticalresponsetoprotectdomestic
industriesthroughvariouscombinationsofdomesticsubsidiesandborderprotection.Thereis
potentialforprotectionism torisefurther.
Theobjectiveofthispaperistwofold:tomodeltheglobalfinancialcrisisandexplorethe
differencesbetweenasharpriseinglobalriskthatispermanentversusonethatexpectedto
betemporary andsecond,toshowtheimpactofthepolicyresponse,especiallythefiscal
response.Todothis,adynamic,intertemporal generalequilibriummodelthatfullyintegrates
thefinancialandrealsectorsoftheeconomyisusedtounravelandunderstandthe
mechanismsatwork.Themodelincorporateswealtheffects,expectationsandfinancial
marketsforbonds,equitiesandforeignexchangeaswellastradeandfinancialflows.Itisa
suitabletooltoanalysetheimpactofthecrisisandpolicyresponsesonglobaltradeand
financialflows.
Thepaperisorganisedasfollows.Inthenextsection,themainfeaturesoftheGCubed
model thatisusedinthisanalysisaredescribedbrieflyasthemodel isdocumentedinfull
elsewhere.
Insection3, thesimulationstorepresentthefinancialcrisisaredescribedandthejustification
forthesizeoftheshockschosen.Itturnsoutfiveshocksareneeded:threeforthecrisisitself
andtwoforthesubsequentpolicyresponseswhichcoversmonetaryandfiscal stimulus2.
Insection4weexploretheimpactof thecrisisandunpicksomeofthemechanismsatwork
byinitiallysurmisingwhatwouldhavehappenedhadtheUnitedStatesalonebeenaffected

1 OECD 2009 http://www.oecd.org/document/12/0,3343,en_2649_37431_42788172_1_1_1_1,00.html

2 See McKibbin and Stoeckel (2009) for an analysis of protectionist responses to the crisis and McKibbin and
Chanthapun (2009) for the transmission to Asia under different exchange rate regimes

2
bythecrisis.Wealsoexplorethecriticalroleofthereappraisalofriskpremiums,in
particularwhethertheshocksarepermanentortemporary3.
TheeffectsofthemassivepolicyresponseareaddressedinSection5.Itturnsoutthatmostof
themonetaryeasingisalreadycapturedbytheendogenousmonetarypolicyruleincorporated
intothemodel,butnotsothefiscalstimulusdeployedaroundtheworldsoweconcentrateon
thisaspectinthissection.
Finally,insection6,someofthemaininsightsarehighlightedanddiscussed.

2. Themodel
TheGCubedmodelisanintertemporalgeneralequilibriummodeloftheworldeconomy.
ThetheoreticalstructureisoutlinedinMcKibbinandWilcoxen(1998)4.Anumberof
studiessummarizedinMcKibbinandVines(2000)showthattheGcubedmodelling
approachhasbeenusefulinassessingarangeofissuesacrossanumberofcountriessincethe
mid1980s.5 Someoftheprincipalfeaturesofthemodelareasfollows:
Themodelisbasedonexplicitintertemporaloptimizationbytheagents(consumersand
firms)ineacheconomy6.IncontrasttostaticCGEmodels,timeanddynamicsareof
fundamentalimportanceintheGCubedmodel.TheMSGCubedmodelisknownasa
DSGE(DynamicStochasticGeneralEquilibrium)modelinthemacroeconomicsliterature
andaDynamicIntertemporalGeneralEquilibrium(DIGE)modelinthecomputable
generalequilibriumliterature.
Inordertotrackthemacrotimeseries,thebehaviorofagentsismodifiedtoallowfor
shortrundeviationsfromoptimalbehavioreitherduetomyopiaortorestrictionsonthe
abilityofhouseholdsandfirmstoborrowattheriskfreebondrateongovernmentdebt.
Forbothhouseholdsandfirms,deviationsfromintertemporaloptimizingbehaviortakethe
formofrulesofthumb,whichareconsistentwithanoptimizingagentthatdoesnot
updatepredictionsbasedonnewinformation aboutfutureevents.Theserulesofthumb
arechosentogeneratethesamesteadystatebehaviorasoptimizingagentssothatinthe
longrunthereisonlyasingleintertemporaloptimizingequilibriumofthemodel.Inthe
shortrun,actualbehaviorisassumedtobeaweightedaverageoftheoptimizingandthe
ruleofthumbassumptions.Thusaggregateconsumptionisaweightedaverageof
consumptionbasedonwealth(currentassetvaluationandexpectedfutureaftertaxlabor
income)andconsumptionbasedon currentdisposableincome.Similarly,aggregate
investmentisaweightedaverageofinvestmentbasedonTobinsq(amarketvaluationof

3 Given the importance of changed risk premia and expectations we explore this issue further in a

companion paper where we also look at what happens when businesses and household initially expect
the worst but then unexpectedly change their view of the world to a temporary scenario. The paper is
McKibbin and Stoeckel (2009b)
4 Fulldetailsofthemodelincludingalistofequationsand parameterscanbefoundonlineat:www.gcubed.com
5 Theseissuesinclude:Reaganomicsinthe1980sGermanUnificationintheearly1990sfiscalconsolidationinEurope
inthemid1990stheformationofNAFTAtheAsiancrisisandtheproductivityboom intheUS.
6 SeeBlanchardandFischer(1989)andObstfeldandRogoff(1996).

3
theexpectedfuturechangeinthemarginalproductofcapitalrelativetothecost)and
investmentbasedonabackwardlookingversionofQ.
Thereisanexplicittreatmentoftheholdingoffinancialassets,includingmoney.Money
isintroducedintothemodelthrougharestrictionthathouseholdsrequiremoneyto
purchasegoods.
Themodelalsoallowsforshortrunnominal wagerigidity(bydifferentdegreesin
differentcountries)andthereforeallowsforsignificantperiodsofunemployment
dependingonthelabormarketinstitutionsineachcountry.Thisassumption,whentaken
togetherwiththeexplicitroleformoney,iswhatgivesthemodelitsmacroeconomic
characteristics.(Hereagainthemodel'sassumptionsdifferfromthestandardmarket
clearingassumptioninmostCGEmodels.)
Themodeldistinguishesbetweenthestickinessofphysicalcapitalwithinsectorsand
withincountriesandtheflexibilityoffinancialcapital,whichimmediatelyflowstowhere
expectedreturnsarehighest.Thisimportantdistinctionleadstoacriticaldifference
betweenthequantityofphysicalcapitalthatisavailableatanytimetoproducegoodsand
services,andthevaluationofthatcapitalasaresultofdecisionsabouttheallocationof
financialcapital.
Asaresultofthisstructure,theGCubedmodelcontainsrichdynamicbehaviour,drivenon
theonehandbyassetaccumulationand,ontheotherbywageadjustmenttoaneoclassical
steadystate.Itembodiesawiderangeofassumptionsaboutindividualbehaviourand
empiricalregularitiesinageneralequilibriumframework.Theinterdependenciesaresolved
outusingacomputeralgorithmthatsolvesfortherationalexpectationsequilibriumofthe
globaleconomy.Itisimportanttostressthatthetermgeneralequilibriumisusedtosignify
thatasmanyinteractionsaspossiblearecaptured,notthatalleconomiesareinafullmarket
clearingequilibriumateachpointintime.Althoughitisassumedthatmarketforces
eventuallydrivetheworldeconomytoneoclassicalsteadystategrowthequilibrium,
unemploymentdoesemergeforlongperiodsduetowagestickiness,toanextentthatdiffers
betweencountriesduetodifferencesinlabormarketinstitutions.
Intheversionofthemodelusedherethereare6sectors(energy,mining,agriculture,
manufacturingdurables,manufacturingnondurablesandservices)and15countries/regions
assetoutinTable2.2.
2.2Countries/regions
UnitedStates

China

Japan

India

UnitedKingdom

OtherAsia

Germany

LatinAmerica

EuroArea

OtherLDC

Canada

EastEurope& FormerSovietUnion

4
Australia

OPEC

Restof OECD

3.Simulatingtheeffectsofthecrisis
Eventsleadinguptothecrisisin2008 thebaseline
Thefocusofthispaperisondisentanglingthemanyinfluencesofthefinancial crisison the
globaleconomyandinparticulartoseehowwellthemodelcanexplainthemacroeconomic
andsectoral responsestothecrisisinconfidencethatwemodelthroughriskshocks.The
crisisisdefinedhereastheburstingofthehousingmarketbubbleinlate2007,theensuing
collapseinthesubprimemortgagemarketandrelatedfinancialmarketsandthesubsequent
collapseofLehmanBrothersin2008whichresultedin asharpincreaseinriskpremiaaround
theworld.
Theprobleminpreciselymodellingthecrisisisthattherearealreadyshocksinthebaseline
thataffectsubsequentglobaldynamicsindependentlyofthecrisis.Herewearefocussing
onlyontheadditionalshocksfromthecrisis.Theproblemisthatsomeof theseedsofthe
financialcrisisweresowninthedecadebeforethecrisis. Therewereaseriesof largeglobal
events,suchastheburstingofthedotcombubblein2001andthe rapidgrowthofChina,that
werealready reshapingthepatternandlevelofworldtradebefore the20072008financial
crisishit.Someoftheseevents,likethelargedisparitiesbetweensavingsandinvestmentin
China(asurplus)andintheUnitedStates(adeficit) ledtolargedifferencesbetweenexports
andimportsforeachnationsothatlargecurrentaccountsurpluseswereaccumulatingin
ChinaandlargedeficitsinAmerica.Somepeople7attributethesegrowingglobalimbalances
ascontributingcausesofthecrisis,andthereissometruthinthat.Butthefocusofthisstudy
isontheimpactofthecrisisitselfonworldtradeandnoton tryingtodisentanglethevarious
contributingfactors tothecrisis,asimportantasthatissueis.
Therefore,besidespopulationandproductivitytrendsshapingthebaselinefortheworld,
someofthekeyeventsoverthelastdecadeinfluencingthebaselinewouldbe:
First,therewastheAsianfinancialcrisisof199798,whichsawAsianeconomies
generatelargecurrentaccountsurplusesthathadtobeinvestedoffshoretokeeptheir
nominalexchangerateslow.CapitalflowedoutofAsiaintoUSdotcomstocksdrivingup
equityprices.
Nextwastheburstingofthedotcombubble,whichsawtheboomingNASDAQover
19982000burstin2001.

7 For example, see Max Corden, The world credit crisis: understanding it and what to do,

http://www.melbourneinstitute.com/wp/wp2008n25.pdf and Martin Wolf, How imbalances led to credit

crunch and inflation, Financial Times, June 17 2008.

5
Fearingadownturnandpossibledeflation,theUSFederalReserveeasedmonetarypolicy
in2001inaseriesofstepsto2004.Somearguethattheyeasedtoomuchfortoolong8.
But,witheasycreditandarisinghousingmarket,aboominhousepricesfollowedanda
periodof highgrowthin creditandleveragedloans.Riskpremiahitlowlevelsand
leverageddealsbecamecommonasinvestorschasedyieldsinanenvironmentoflax
regulatoryoversight.
RisingdemandsfromChina(and,tosomeextent,India),plusaboomingworldeconomy
sawcommoditypricesriseacrossoil,mineralsandfoodfromlate2004tolate2007.The
shocktotheglobaleconomy fromthiscommoditypriceboom wasasbigasthefirstoil
shockinthe1970s9.
Risingpricesandinflationcausedmonetaryauthoritiestotightenpolicyfrommid2004to
June2006.
Eachofthesemajoreventssetuptheirowndynamicsforthecourseoftheworldeconomy
andhelpedshapetheunderlyingbaseline.Someoftheseeventssuchastheeasingand
tighteningofmonetarypolicyareendogenoustothemodelandalreadyincorporatedinthe
baseline. Itisimportanttoappreciatethattheresultsreportedherearedeviationsfrom
baselinefromthefinancialcrisis,asdefinedhere.Whatisimportantistherelative
contributionofdifferenteffectsandtodisentangletheimpactsofthefinancialcrisison the
globaleconomyintheshorttomediumrun.
Thefive shockstorepresentthecrisisandthepolicyresponses
Theaboveeventshaveledtothenowwellknownglobaldownturn.Allofficialforecasting
agencies,suchastheIMFandOECD,havedescribedthisdownturnandsowillnotbe
expandedhere.AstheIMFnotesGlobalGDPisestimatedtohavefallenbyan
unprecedented5percentinthefourthquarter(annualized),ledbyadvancedeconomies,
whichcontractedbyaround7percent10.Japanhasbeenparticularlyhardhitwithafourth
quarterGDP (2008) plummetingby13percent.Demandfordurablegoodshasbeen
particularlyhardhit.Withthedownturntherehasbeenasharpupturninsavingsby
households(andcommensuratereductioninconsumption),drivenbyareappraisalofriskby
householdsandalossofnetworthwithfallinghousepricesandequityprices.Soshocks
needtobedevisedtoaccountforthreethings
Theburstingofthehousingbubbleandlossinassetpricesandhouseholdwealthwith
consumerscuttingbackonspendingandliftingsavings.

8 Notably John Taylor, see Taylor, J.B. 2008, The Financial Crisis and the Policy Responses: An Empirical

Analysis of What Went Wrong.

9 The impact of productivity growth in the developing countries, particularly China are considered in

McKibbin and Cagliarini (2009)

10 IMF 2009, Group of Twenty, Meeting of the Ministers and Central Bank Governors March 1314, 2009, London

UK, p. 4.

6
Asharpreappraisalofriskwithaspikeinbondspreadsoncorporateloansandinterbank
lendingrateswiththecostofcredit,includingtradecredit, risingwithacommensurate
collapseof stockmarketsaroundtheworld.
Amassivepolicyresponseincludingamonetarypolicyeasing,bailoutsoffinancial
institutionsandfiscalstimulus.
Thesethreeoutcomescanberepresentedbyfiveshocksthreeforthecrisisitselfandtwo
forthepolicyresponse.
Three main shocks capture the onset of the global financial crisis:

1. Theburstingof thehousingbubblecausingareallocationofcapitalandalossof
householdwealthanddropinconsumption.
2. Asharpriseintheequityriskpremium(theriskpremiumofequitiesoverbonds)causing
thecostofcapitaltorise,privateinvestmenttofallanddemandfordurablegoodsto
collapse.
3. Areappraisalofriskbyhouseholdscausingthemtodiscounttheirfuturelaborincomeand
increasesavingsanddecreaseconsumption.
Shock1:Theburstingofthehousingbubble
Fallinghousepriceshasamajoreffectonhouseholdwealth,spendinganddefaultsonloans
heldbyfinancialinstitutions.EventsintheUnitedStatestypify aglobal phenomenon.From
2000to2006,housepricesinsomeareasdoubledtosubsequentlycollapse(chart3.1). These
changesinsomeareashavegenerateddramaticnewsheadlinesbut,overalltheUnitedStates
indexofhousepriceshasfallenby6.2percentinrealtermsfromthe1st quarter2008tothe
samequarterin200911.
Whilehousepriceswererisingsostrongly,creditwassuppliedliberallytomeetthedemand
asperceptionsofriskfell.Therisingwealthboostedconfidenceandspending.Thehousing
bubblewasaglobalphenomenoncenteredmainlyontheAngloSaxonworld.

11 Federal Housing Finance Agency May 2009, http://www.fhfa.gov/webfiles/2406/1q09hpi.pdf

7
3.1 UShousepricesrelativetopercapitahouseholdincome
220

220

Inthesunbeltashousepricesrose,
perceptionsofriskdeclinedand
creditstandardsdeclinedboosting
demandanddrivingpriceshigher.
Asthebubbleburst,seemingly'safe
asbricksandmortar'investments
lostalmosthalfoftheirvalue,oneof
therootcausesofthecurrent
financialproblems.Butpricesare
nowmuchclosertofairvalue.

200

Index2000=100

180

160

LosAngeles

200

Miami

180

160

Phoenix

140

120

140

120

National
100

100

80

80

Nov1987

Nov1990

Nov1993

Nov1996

Nov1999

Nov2002

Nov2005

Nov2008

aNotes:Seriesshownarehousepricesoverpercapitahouseholdincome.Forcomparisonseriesare
indexedtoacommonbase2000=100.IndividualcitiesarefromtheS&PCaseSchillerindex.National
pricesarefromtheOFHEO.OFHEOdatahasacompletecoverageoftheUSwhiletheCaseSchiller
indexonlycoversthelargest20cities.OFHEOandCaseSchillerdataforindividualcitiesindicate
similarmovementsi.e.differencesintheserieslargelyreflectthecoveragedifferences.(Thewidely
reportedCaseSchillerindexshowsmuchlargerfallsthantheOFHEOindex.)
Datasource:StandardandPoors,OfficeofHousingEnterpriseOversight,OECDEconomicOutlook
Database.

Thehousingbubblewastheresultofalongperiodoflowinterestratesby theUSFederal
Reserve.TheFederalReservecutinterestratesbyatotalof550basispointsinaseriesof
stepsbetween2001and2004.Theeasing,subsequenttighteningandcurrenteasingare
showninchart3.2.Somebelieve(forexampletheAustrianschoolandJohnTaylor12),that
monetarypolicywastooloosefortoolongandthisiswhatgaverisetotheassetpricebubble
andcommoditypricespike.TaylorarguesthathadtheFederalReservefollowedtheTaylor
rule(actuallytheHendersonMcKibbinTaylorrule),interestrateswouldhaverisenmuch
soonerandthebubblesnotappeartothesameextent(chart3.2).

12 Taylor, J.B. 2008, The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong,

p. 2.

8
3.2 Federalfundsrate Actualandcounterfactual
9

Federalfundsrate(%)

8
7
Actual
6
Taylorrule

5
4
3
2
1
0
Jan90

Jan92

Jan94

Jan96

Jan98 Jan00

Jan02

Jan04

Jan06

Jan08

Note:Thedailyeffectivefederalfundsrateisaweightedaverageofratesonbrokeredtrades.Weekly
figuresareaveragesof7calendardaysendingonWednesdayofthecurrentweekmonthlyfigures
includeeachcalendardayinthemonth.Annualisedusinga360dayyearorbankinterest.
Datasource:USFederalReserveStatisticalRelease,
http://www.federalreserve.gov/releases/h15/data/Monthly/H15_FF_O.txt,Accessed5March2009.

Whilelowinterestrateswereduetofearsof deflation13andledtoaboominUShousing,
lowinterestrateswerenotjusttheresultoftheFedsactions.USbondyieldswerealsolow
becauseoflowworldrates(withJapanesebondyieldsatalittleover1percentandshort
terminterestratesatzero).TherewasalsoaninternationalaspecttolowUSinterestrates
withJapanandEuropeonlyrecoveringveryslowlyfromthe200001downturnandinturn
placingpressureontheUStokeepinterestrateslow.InJapantherewerefearsofre
emergentdeflation.ThatistheprincipalreasonwhyinterestrateswerekeptlowintheUSfor
anunusuallylongterm untilmid2004whentheFedbeganaverysharptightening
cycle14.Thelowinterestratesthrough200304 besidesfuellingaboominbanklending,
risingassetpricesandrisingdemandinChinaandotherdevelopingcountriesalsofuelled
acommoditypriceboom.
However,onlyapartofthedwellingboomandthecommodityboomcanbeattributedtothe
actionsoftheFed.TheuptrendinUShousepriceswasevidentasearlyas2000.Assmall
investorsabandonedthestockmarketin2001,theydivedintothehousingmarket,drivingup
andsustainingthepricerises.Similarly,thesurgeincommoditypricesthrough2005to2008,
whichtookmostanalystsbysurprise,hadasmuchtodowithdevelopmentsinChina,andthe
laggedresponseofsupply,astheydidwithanincreaseindemandinNorthAmerica.Where
therealproblemlaywasinthecombinationofthetwo.
Theburstingofthehousingbubbleismodelledasasurprisefallintheexpectedflowof
servicesfromhousinginvestmentlargerintheUnitedStates,UnitedKingdomandEurope
butstillsignificantthroughouttheworld. Inthemodel,thehouseholdineacheconomyis
modelledassolvinganintertemporalconsumptionproblemsubjecttoanintertemporal

13 For example, see Alan Greenspans account in The Age of Turbulence, Allen Lane, 2007, pp228229.
14 The sharpest, in fact, since the Volker deflation of the early 1980s.

9
budgetconstraint.Theresultisatimeprofilefortheconsumerineachcountryof
consumptionofgoodsfromallcountriesbasedonexpectedfutureincomeandexpected
relativegoodsprices.Thehouseholdalsochoosesinvestmentinacapitalgood.The
householdcapitalstockcombineshousing,andotherdurablegoods.Forsimplicityof
expositionwewillrefertothiscapitalgoodashousingfromhereon.
Theinvestmentdecisionbyhouseholdsismodelledanalogouslytohowwemodelthe
investmentdecisionsoffirmswithinanintertemporalframeworksubjecttoadjustmentcosts
forcapitalaccumulation.Thehouseholdinvestsinhousingtomaximizeconsumptionfrom
thestreamoffutureserviceflowsthathousingprovides.Thisstreamofservicesisanalogous
toaproductionfunctionbasedoninputsofcapitalandaproductivityterm.Wemodelthe
housingpartofthecrisisasafallintheproductivityoftheserviceflowfromthehousing
stock.ThisfallinexpectedfutureproductivityofhousingmeansthattheTobinsqfor
housingdropswhentheshockoccurs. ThedropinhousingproductivityintheUnitedStates
isassumedtobe10percentlowerin2009andiscalibratedtogive,alongwiththeother
shocks,adropinhousepricesintheUSoftheorderof 6percent, roughlywhathasbeen
observedforthelastyear15.Aplausiblescenarioiswhereproductivityreturnstonormalby
2013.
Shock2:Risingequityriskpremia
Thesurpriseupswingincommoditypricesfrom2003butmostnoticeableduring2006and
2007ledtoconcernsaboutinflationleadingtothesharpreversalinmonetarypolicyinthe
US. ThistighteninginUSpolicyalsoimpliedatighteningofmonetarypolicyineconomies
thatpeggedtotheUSdollar.ItwasthesharpnessofthisreversalasmuchasthefallinUS
housepricesandthefailuresoffinancialregulation(forexample,themortgageunderwriters
FannieMaeandFreddieMac)thatledtothefinancialproblemsfor20080916.Lehman
BrothersfailurewasprimarilyduetothelargelossestheysustainedontheUSsubprime
mortgagemarket.Lehman'sheldlargepositionsinthesubprimeandotherlowerrated
mortgagemarkets.ButmortgagedelinquenciesroseaftertheUShousingpricebubbleburst
in200607.Inthesecondfiscalquarter2008,Lehmanreportedlossesof$2.8billion.Itwas
forcedtoselloff$6billioninassets17. ThefailureofLehmanBrothersinSeptember2008
andeffectonriskpremiumsacrossmarketscanbeseenclearlyonchart3.3.

15 A 10 per cent permanent drop in housing productivity in the United States alone gives a 5.4 per cent

drop in housing values one year later. See McKibbin, W and Stoeckel, A, Bursting of the US housing
Bubble, Economic Scenarios No 14, www.economicscenarios.com.
16 Similarly, the tightening cycle of the mid1980s was one factor leading to the Savings and Loan crisis.
17 New York Times, Thursday, 26 February 2009.

10
3.3 TheLehmanBrothersbankruptcyandriskpremia
7

Riskpremiumon
Corporatebonds(BAA
rated)

Theriskpremiumonshortterminterbank
borrowingrosesharplywhenLehmanBrothers
enteredChapter11bankruptcyprotectionin
September2008.Thispushedupthepremiumon
corporateborrowingrelativetoUStreasuries.As
therealeconomyhasdeteriorated,corporaterisk
premiahaveremainedextraordinarilyhigh.

%points

4
Sep11
attacks

2
Lehman
bankruptcy

Riskpremiumon
interbankborrowing
1

30Jul2001

30Jun2003

30May2005

30Apr2007

30Mar2009

aNotes:Weeklydata.Riskpremiumoninterbankborrowingapproximatedbytherateononemonth
EurodollardepositslesstheFederalfundsrate.Riskpremiumoncorporatebondsmeasuredasthe
yieldonBAAratedcorporatebondslessthe10yearTreasurybondyield.
Datasource:FederalReserveBoard.

Permanent versus temporary shock

Theinitial riseintheequityriskpremiumsincethecollapseofLehmanBrothershas

beenoftheorderof8percentagepoints.Butwhatwillmatterfortheresultsiswhether
theinitialriseinequityriskpremiumcontinuesintothefutureandisindicativeofa
newstateofaffairsbybusinessorwhetheritturnsouttobetransitory.Argumentscan
bemadeeitherway.Atthetimeofthecrisistherewasplentyofcommentary,someof
itfromofficialinstitutions,aboutdireconsequencesandparallelsdrawntotheGreat
Depression.Butthepolicyresponsewasalsomassivewiththeclearintentionofgetting
thingsbacktonormalassoonaspossible.Henceunderthisshockofariseinequity
riskpremium,toseethedifferenceitmakes,wemodel twoscenariosonewherethe
riskpremiumispermanentlyhigherby8%andtheotherascenariowheretherisk
premiumfallsbyhalfinyear2andthenisbacktobaselinebyyear3.Welabelthefirst
onepermanentandthesecondtemporary.
Shock3:Ariseinhouseholdrisk
Thereappraisalofriskbyfirmsasaresultofthecrisisalsoappliestohouseholds.As
householdsviewthefutureasbeingmorerisky,sotheydiscounttheirfutureearningsand
thataffectstheirsavingsandspendingdecisions.Aswiththepreviousshock,wemodeltwo
scenarios:onepermanentandtheothertemporary.Theincreaseinhouseholdriskinthe
UnitedStatesisassumedtobe3percentagepointsinthepermanentscenarioandreturningto
zerobyyearthreeinthetemporaryscenario.

11
Summaryofthreecrisisshocksandcountrydifferences
Thethreeshocksby sector theUnitedStatesareshownintable3.4.
3.4 Equityriskpremium,householdriskandhousingproductivityfortheUnited
Statesunder thetemporaryandpermanentscenarios

Permanentscenario
Equityriskpremiumby
sector:
Energy
Mining
Agriculture
durablemanufacturing
nondurable
manufacturing
services
Householdrisk
Housingproductivity
Temporaryscenario
Equityriskpremiumby
sector:
Energy
Mining
Agriculture
durablemanufacturing
nondurable
manufacturing
services
Householdrisk
Housingproductivity

2009

2010

2011

2012

2013

2014on

8
8
8
8

8
8
8
8

8
8
8
8

8
8
8
8

8
8
8
8

8
8
8
8

8
8

8
8

8
8

8
8

8
8

8
8

3
10

3
8

3
6

3
4

3
4

3
4

8
8
8
8

4
4
4
4

0
0
0
0

0
0
0
0

0
0
0
0

0
0
0
0

8
8

4
4

0
0

0
0

0
0

0
0

3
10

1.5
5

0
0

0
0

0
0

0
0

Source:authorscalculations.

Theshocksintable3.4arefortheUnitedStates theepicentreofthecrisis.Butnotall
countrieshavebeenequallyaffectedbythecrisis.Forexample,durablemanufacturingin
Japanwouldbehitharderbytheriskreappraisalgiventhecollapseoftheirdurableexports
(dominatedbycars)asaresultofthecombinationoftheglobaldownturnandthe
appreciationoftheYen thatresultedfromthecollapseincommoditypricesandimprovement
intheirtermsoftrade.
Also,JapanhadtheirhousingbubbleadecadeearlierthandidtheUnitedStates,sooverthe
lastfewyearsthey neverexperiencedapropertybubbleasinAmerica.Sotheshocktotheir
economyfromtheburstingofthehousingbubblewouldbelessthanfortheUnitedStates.

12
Therefore theshocksforequityrisk,thehousingbubbleburstingandhouseholdriskare
scaledofftheUnitedStates.TakingtheUnitedStatesas1aseriesofweightsforother
sectorsandeconomiesappearsintable3.5.

3.5 Weightforcountryandsectorshocks
USA
Equityriskby
sector
energy
mining
agriculture
durable
manufacturing
nondurable
manufacturing
services
Householdrisk
Household
productivity

JPN GBR DEU EUR CAN AUS OEC

CHI

IND OAS LAM LDC EEB OPC

1
1
1

1
1
1

1
1
1

1
1
1

1
1
1

1
1.2
1

1
1.2
1

1
1
1

0.8
0.8
0.8

0.8
0.8
0.8

0.8
0.8
0.8

0.8
0.8
0.8

0.8
0.8
0.8

0.8
0.8
0.8

0.8
0.8
0.8

1.2

1.2

0.8

0.8

0.8

0.8

0.8

0.8

0.8

1
1

1
1

1
1.2

1
1

1
1

1
1

1
1

1
1

0.8
0.8

0.8
0.8

0.8
0.8

0.8
0.8

0.8
0.8

0.8
0.8

0.8
0.8

0.3

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.1

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

Two mainshockscapturethepolicyresponses
Ontopoftheabovethreefinancialcrisisshockstherehasbeen an unprecedentedpolicy
responsecomprisingthreemoreelements:
4. Aneasingofmonetary policy tonearzeroofficialratesofinterestinmajordeveloped
economies.
5. Aneasingoffiscal policy acrosscountriesandlargerunupin governmentdeficits.
Shock4:Monetaryeasing
Thereisanendogenousmonetaryresponseinthemodelforeacheconomy whereeach
economyfollowsaHendersonMcKibbinTaylorruleasshowninequation(1)withdifferent
weightsoninflation()relativetotarget,outputgrowth(y)relativetopotentialandthe
changeintheexchangerate(e)relativetotarget.
T

T
T
it =it-1+b1(p t p t )+ b 2(Dyt D yt )+ b 3(Det D et )

(1)

TheassumedparametervaluesaresetoutinTable3.6.NotethatChinaandmostdeveloping
economieshaveanonzeroweightonthechangeinthe$USexchangerate. Themonetary
easingthathasoccurredisclosetotheendogenousmonetarypolicyresponsealreadybuilt
intothemodelsoanyextramonetarystimulusisnotrequired.Ofcourseitispossiblethat
authorities,beingfearfulofraisinginterestratestooearlyandprickingthenascentrecovery,
couldendupeasingtoomuchfortoolongandwouldbeaninterestingsimulation,especially
ifdifferentcountrieschosedifferentamountsofovereasingwhichwouldsetupcapital
flowchangesandhencetradeflowchanges.

13
3.6:CoefficientsinHendersonMcKibbinTaylorRulesinEachCountry
inflation(1) outputgrowth(2) $USExchangerate(3)
USA
0.5
0.5
0
JPN
0.5
0.5
0
GBR
0.5
0.5
0
DEU(*)
0.5
0.5
0
EUR(*)
0.5
0.5
0
CAN
0.5
0.5
0
AUS
0.5
0.5
0
OEC
0.5
0.5
0
CHI
0.5
0.5
1
IND
0.5
0.5
0
OAS
0.5
0.5
1
LAM
0.5
0.5
1
LDC
0.5
0.5
1
EEB
0.5
0.5
1
OPC
0.5
0.5
10
(*)NotethatGermany(DEU)andtherestoftheEurozone(EUR)havea
commoninterestratewithaweightonEuropeanwideinflationandoutputgap.

Shock5:Fiscaleasing
Thereisanendogenousfiscalpolicyresponseinthemodelbuttheruleisatargetingoffiscal
deficitsasapercentof GDP.Theeasingoffiscalpolicyannouncedbymosteconomieshas
beenanextraunprecedentedstimulusinthemoderneraandexpansionoffiscaldeficitsand
hastobesimulated.
Thediscretionarystimuluspackagesannouncedbyeachcountryhavemainlyoccurredover
2009and2010andisusefullysummarisedbytheOECD18.FortheUnitedStatesthe
cumulativestimulusisnearly5percentofGDPandforChinaitisover11percentofGDP.
Itisunlikelythatsuchastimuluswillsuddenlyendin2010fortworeasons:itishardto
crankupgovernmentspendingonthingslikeinfrastructurequicklyandgovernmentsusually
findithardtoreigninspendingquicklyonceprogramsareannounced.Therefore,whilst
assumingthesamecumulativefiscalresponseasoutlinedbytheOECDandotherstudies,the
fiscalresponsehasbeenassumedtotaperoffquicklyafter2010butfinishingin2012.The
assumedfiscalresponseisoutlinedintable3.7.

18 OECD 2009, Fiscal Packages Across OECD Countries: Overview and Country Details, Paris, 31 March.

14
3.7The assumed fiscal policy responsepercentofGDP

Country/region
UnitedStates

2009

2010

2012

2013 Cumulative

2.07

1.55

1.04

0.52

5.18

Japan

1.46

1.10

0.73

0.37

3.65

UnitedKingdom

1.32

0.99

0.66

0.33

3.29

Germany

1.38

1.04

0.69

0.35

3.45

Euroarea

1.30

0.98

0.65

0.33

3.25

Canada

1.68

1.26

0.84

0.42

4.20

Australia

2.48

1.86

1.24

0.62

6.21

RestofOECD

1.00

0.75

0.50

0.25

2.50

China

4.80

3.60

2.40

1.20

12.00

India

0.50

0.38

0.25

0.13

1.25

OtherAsia

2.00

1.50

1.00

0.50

5.00

LatinAmerica

0.50

0.38

0.25

0.13

1.25

OtherLDC

0.50

0.38

0.25

0.13

1.25

EEFSU

1.70

1.28

0.85

0.43

4.25

OPEC

3.00

2.25

1.50

0.75

7.50

Source:OECD2009andauthorscalculations.

4. Effectsofcrisiswithouta fiscalpolicyresponse
Mechanismsatwork
Toappreciatethemechanismsatworkfromthethreeshocksanillustrativescenariowhere
permanentshocksaffecttheUnitedStatesaloneisshowninchart4.1.Theburstingofthe
housingbubblehasthebiggestnegativeimpactonrealconsumption,whichbeingroughly70
percentofthedomesticeconomy,hasthebiggestnegativeimpactonrealGDP.The
permanentlossinwealthcausesconsumptiontofallsharplyandbecausethehousingshockis
assumedtobepermanent,consumptionispermanentlylowerinallperiodsasshownon
Chart4.1.
Thefinancialshockhasthelargestnegativeimpactonstockmarketvaluesfrombaselinein
2009andanequallylargeimpactastheburstingofthehousingbubbleoninvestment.The
equityriskshockcausesashiftoutofequitiesintootherdomesticassets,suchashousingand
governmentbondsaswellastoassetpurchasesoverseas.Theshiftintogovernmentbonds
drivesuptheirpricesandpushesdownrealinterestratessubstantially.Thissurprisingly
raiseshumanwealthbecauseexpectedfutureaftertaxincomeisdiscountedatamuchlower
real interestrate.ThusintheUS,theequityshockaloneispositiveratherthannegativefor
consumptionintheshortrun.
Investmentontheotherhandfallssharply.TheequityshockreducesUSinvestmentbyabout
20percentbelowbaseline.Theriseinequityriskimpliesasharpselloffofsharesduetoa

15
largeriseintherequiredrateofreturntocapital.Thehigherequityriskpremiumimpliesthat
theexistingcapitalstockistoohightogeneratethemarginalproductrequiredfromthe
financialarbitrageconditionandinvestmentfallsand,overtime,duetotheexistenceof
adjustmentcosts,thecapitalstockfallsandpotentialoutputispermanentlyreduced.
UnderthissimulationwheretheUSaloneisassumedtobeaffectedbythecrisis,thereisa
largeimpacton USexports(bottomlefthandpanelofchart4.1)becausethereisalarge
capitaloutflowfromtheUSasUSsaversinvestoffshoreinthehouseholdriskshock.TheUS
trade balanceimprovesby4percentofGDPprimarilyduetoasharpdepreciationoftheUS
dollar.
EachofthethreeshockshasanegativeeffectontheUnitedStatesand,combined,hasthe
effectofloweringrealGDPby7percentbelowbaselinein2009andrealGDPdoesnot
returntobaselineuntil2017,nearlyadecadelater. ThatissufficienttoputtheUSinto
recessionin2009(baselinegrowthis3.4percent)butwillallowpositivegrowthin201019.
Akeycompositionaleffectalsooccurswhenhouseholddiscountratesriseandriskpremia
generallyrise.Theeffectisamuchsharperfallinthedemandfordurablegoodsrelativeto
othergoodsintheeconomy.ThisisshownclearlyinChart4.2.Importsanddomestic
productionofdurablegoodsfallsbymorethannondurablegoods.Thedifferencesare
substantial.Thehighriskadjustedcostleadstoareductionintheflowofservicesfrom
durablesandthereforethedemandforthesegoodsdropssharply.Thiscompositionaleffectis
criticalforthetradeoutcomes.Countriesthatexportdurablegoodsareparticularlyaffected
by acrisisofthetypemodelled.
TherecessionintheUnitedStateshastwomaineffectsontheworldeconomy.Oneisthe
negativeknockoneffectfromthelossinactivitywiththoseeconomiesmostdependenton
theUnitedStatesmarketmostaffected.Thesecondeffectrunscountertothefirst.As
prospectsdimintheUnitedStates,sothereturnsoninvestmentlookbetterelsewhere.Money
flowsoutoftheUnitedStates(orstrictlyinthecaseoftheUS,lessinflowthanotherwise)
andintoothereconomieswhereitstimulatesinvestmentandeconomicactivity.Thisis
illustratedbytheeffectonChina(seechart4.3).TheUnitedStatesisalargeimporterfrom
China.AsUSimportsfall,Chinasexportsfall(seebottomlefthandpanelof4.3),witha
combinedeffectfromthethreeshocksofadropin

19 Note that all results are presented as deviations from a baseline projection. A fall in GDP of 7% in year 1,

relative to baseline, where the baseline growth rate was 3.4% is a new growth rate in the first year of
negative 3.6% (i.e. a recession). If the level of GDP remains 7% lower forever, the growth rate of GDP in
year 2 is back at baseline growth. Thus in growth rate terms, the crisis is resolved after the first year in
many countries although the level of GDP remains below baseline for many years.

16
4.1 ImpactofaUSonlyPermanentfinancialcrisisontheUnitedStates
USConsumption

USGDP
1

9 10 11 12
5.00

0.00

0.00

%deviation

%deviation

0
2.00

2.00
4.00
6.00

9 10 11 12

5.00
10.00
15.00

8.00

20.00
housing

financialrisk

householdrisk

GFC

housing

financialrisk

USStockMarketValue
0

9 10 11 12

%deviation

%ofbaselineGDP

5.00
0.00
5.00
10.00
15.00
20.00
25.00
financialrisk

householdrisk

GFC

housing

9 10 11 12

4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
housing

financialrisk

householdrisk

GFC

financialrisk

9 10 11 12

householdrisk

GFC

9 10 11 12

financialrisk

householdrisk

GFC

USInflationRate
7

9 10 11 12

30.00
25.00
20.00
15.00
10.00
5.00
0.00
5.00
10.00
15.00
housing

2.00
1.00
0.00
1.00
2.00
3.00
4.00
5.00
6.00
housing

%change

%pointdifference

financialrisk

USExports
0

USRealInterestRate

%pointdifference

%ofbaselineGDP

20.00
10.00
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00

USTradeBalance
0

GFC

USInvestment

10.00

housing

householdrisk

householdrisk

GFC

Datasource:GCubedmodelsimulations

9 10 11 12

6.00
5.00
4.00
3.00
2.00
1.00
0.00
1.00
2.00
3.00
4.00
housing

financialrisk

householdrisk

GFC

17
4.2 ImpactofaUSonlypermanentfinancialcrisisonDurablesverusNonDurable
goodsintheUnitedStates
ProductionandImportsofDurablesandNonDurables
0

%deviationfrombaseline

10

15

20

25

30

35

40

45
durablesimports

nondurablesimports

durablesproduction

nondurablesproduction

Datasource:GCubedmodelsimulations

exportsof5percentbelowbaselinein2009.Chinastradebalanceworsens,butnotehow
smalltheeffectis:barely1percentbelowbaseline(asapercentofGDP).
NotealsothenetsmalleffectonChinasrealGDPeventhoughChinasexportsarealarge
proportionoftheirGDP.WhentheUnitedStatesaloneisaffectedbythecrisis,thereisa
smallcombinedeffectonChinaofareductioninrealGDPof0.75percentbelowbaselinein
2009andapositiveeffectfrom 2011onwards.LookingatChinasrealinvestmentprovides
theanswer.BecauseinvestmentprospectsintheUnitedStatesarenowdireunderthe
combinedscenario,moneyflowselsewhere,onerecipientof whoisChina.Chinasreal
investmentcouldbe3.5percentabovebaselinein2011and2012,inresponsetothe
relatively betterinvestmentprospects. ChinagainsattheUnitedStatesexpense.The
favourablestimulusfromextrainvestmentlargelyoffsetsandeventuallyoutweighsthe
negativeeffectsfromthelossofexportstotheUnitedStates.
TheconclusionisthatthefinancialcrisiswhichstartedintheUnitedStates,haditbeen
confinedtotheUSalone,wouldnothavehaddireconsequencesfortheworldeconomy.Of
coursethereal storyisdifferent.Contagionandrisingriskpremiumseverywherehavecaused
adifferentscenario.WheneveryoneisaffectedtheconsequencesfortheUnitedStatesalso
dependsonwhoandhowothercountriesareaffected.

18
4.3ImpactofaUSonlypermanentfinancialcrisisonChina
ChinaConsumption

ChinaGDP
1

9 10 11 12
5.00

3.00

4.00
%deviation

%deviation

0
4.00

2.00
1.00
0.00

9 10 11 12

3.00
2.00
1.00
0.00
1.00

1.00

2.00
housing

financialrisk

householdrisk

GFC

housing

financialrisk

ChinaStockMarketValue
1

9 10 11 12

12.00

25.00

10.00

20.00

8.00
6.00
4.00
2.00

0.00

GFC

housing

9 10 11 12

9 10 11 12

householdrisk

GFC

9 10 11 12

1.00
%pointdifference

%ofbaselineGDP

ChinaRealInterestRate

0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50

0.00
1.00
2.00
3.00
4.00
5.00
6.00

housing

financialrisk

householdrisk

GFC

housing

financialrisk

ChinaExports
0

9 10 11 12

0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
housing

financialrisk

householdrisk

GFC

ChinaInflationRate
0

%change

%pointdifference

financialrisk

ChinaTradeBalance
0

5.00

5.00
householdrisk

10.00

2.00
financialrisk

15.00

0.00

housing

GFC

ChinaInvestment

%deviation

%ofbaselineGDP

householdrisk

householdrisk

GFC

9 10 11 12

6.00
5.00
4.00
3.00
2.00
1.00
0.00
1.00
2.00
3.00
housing

financialrisk

householdrisk

GFC

Datasource:GCubedmodelsimulations

Projectedoutlookfromtheglobalfinancialcrisis withoutfiscalstimulus
Whenall economiesareaffectedbytheglobalfinancialcrisisthroughglobalchangesinrisk
premiaandlossofconsumerconfidence,othercountrieslikeChinaareadverselyaffected.
When othereconomiesarealsoadverselyaffected bythereappraisalofrisk,thecostof

19
capitalforthemalsorisesand,ineffect, causestheexistingcapital stock tobetoolarge.
Equitymarketsplummetasshowninchartset4.4. Investmentplummets,butnoteverywhere
becauseitisrelativeeffectsthatmatter.Theimpactoninvestmentisshownin chartset4.5.
WhereasChineseinvestmentrosewhenjusttheUnitedStateswasassumedtobeaffectedby
thecrisis,nowChineseinvestmentfallstoalowofover10percentbelowbaselinein2010
underthepermanentriskshock
Undertheassumptionsofthesmallerrisein riskpremiaacrosstherestofAsia,Latin
AmericaandLDCs,theseregionsgain relatively fromtheglobalreallocationofinvestment.
Investmentin OtherAsiacouldbe2to4 percenthigheroverbaselinein 2009and2010.
India,China,Australia,otherAsia,Latin AmericaandotherLDCsdonotgointorecession
(seechartset4.6)asaresultoftheglobalfinancialcrisisasrepresentedbythethreeshocks
usedinthisstudy.WhilesomeLatinAmericaneconomiessuchasArgentinaarenotfaring
well atthemoment,thereareotherforcesatworksuchasdroughtandtheimpactoftaxeson
theirexports. Theresultsinchartset4.7 doshow thatexportsfrom allregionstobehithard,
however.Inmostregionsexportsarevariously8to14percentbelowbaselinein2009with
exportsfromAustraliaandIndia20to25percentdownoverthefullyearandcontinueto
remainlowinthecaseofthepermanentscenario.
Oneofthekeyfeaturesofthecrisisisreflectedintheresultsin chartset4.6and4.7.Thereis
asubstantiallylargercontractioninexportsrelativetothecontractioninGDPinall
economies.ThismassiveshiftintherelationshipbetweentradeandGDPisnottheresultof
anassumptionabouttheincomeelasticityofimports.Itreflectssomekeycharacteristicsof
themodel.First,importsaremodelledonabilateralbasisbetweencountrieswhereimports
arepartlyforfinaldemandbyhouseholdsandgovernmentandpartlyforintermediateinputs
acrossthesixsectors.Inaddition,investmentisundertakenbyacapitalsectorthatuses
domesticandimportedgoodsfromdomesticproductionandimportedsources.As
consumptionandinvestmentcollapsemorethanGDP,importswillcontractmorethanGDP.
Onecountrysimportsareanothercountrysexportsthusexportswillcontractmorethan
GDPunlessthereisachangeinthetradepositionofaparticularcountry.Theassumption
thatall riskpremiariseandtheresultsthatallrealinterestratesfallseverywhereimplies
smallchangesintradebalances.
Outcomes for permanent versus temporary risk scenarios

Charts4.4to4.7showsomelargedifferencesdependingonwhethertheshocktoequityrisk
andhouseholdriskispermanentortemporary.Thefirstobservationisthat,asexpected,the
impactsonthestockmarket,investmentandexportsismuchgreaterandlongerlastingwhen
theshockispermanentthanwhenitistemporary.Whereasthedeclineinstockmarketsisup
to20oreven25percentbelowbaselinein2009underthepermanentscenario,underthe
temporaryscenariothedeclineisaround5percent. Thatis,eventhoughinitialshocktorisk
premiaunderthepermanentandtemporaryscenariosisthesamein2009,inmanycasesthe
effectcanbethreetofivetimesgreater,andlongerlasting,whentheshockisexpectedtobe
permanent,comparedtooutcomeswhentheshockisexpectedtobe temporary.Thereasonis
expectations.Asdescribedearlier,becausethisisafullyspecifieddynamicintertemporal
general equilibriummodel,forwardlookingbehaviourby someagentsinthemodel hastobe
allowedfor.Underthetemporaryscenario,householdsandbusinessesexpectriskpremiums

20
tocomedownandbehaveaccordingly.Thisgroupofforwardlookinghouseholdsandfirms
partlyseethroughtheshock.Hencethestockmarketdoesnotfallasmuch,thecollapsein
investmentislessandtheimpactontradeisless.
Twoareaswherethereislessinitialdifferencebetweenthepermanentandtemporary
scenariosisoutcomesforrealGDPandrealinterestrates(chartset4.6andappendixchartset
C.3).In2009,thedifferencesinrealGDPoutcomesasbetweenthetwoscenariosaremainly
confinedtotheUnitedStatesandtheUnitedKingdom.Thereasonsaremainlydueto the
differencesin theassumedhouseholdriskshocksinthecaseofJapanandGermanyandto
thesmallerinvestmenteffectsfortheothersforthereasonsnotedabove.Insubsequentyears
thedifferencesinrealGDPoutcomesbetweenthetwoscenariosforallregionscanbe
substantial.Thereasonisthatunderthepermanentincreaseinriskpremiumsthestockof
capitalshrinkspermanentlyandsodoesrealGDP.
Forrealinterestrates(chartsetC.3intheAppendix)thereisaninitial falleverywhere.
Initiallythefall ininterestratesisby around400basispointsbothreflectingalongrun
declinein themarginalproductofcapitalbutalsoreflectingaresponseofmonetary
authoritiesinloweringnominalinterestrates. Butthereisadifferenceinrealinterestrate
outcomesbetweenthepermanentandtemporary scenariosinsubsequentyears.Underthe
temporaryshock,realinterestrateshaverecoveredbacktobaselineorevenslightlyaboveby
2011duetotheexpectedreturntonormalriskpremiums.
Thedifferencesinresultsbetweenpermanentandtemporaryriskpremiumsposeadilemma
forrepresentingtheglobalfinancialcrisisinamodelsuchastheoneusedhere.Initial
outcomesaroundtheworldareindicativeofthepermanentriseinriskpremiums.But
subsequentdevelopmentsinfinancialmarketsshow thatthetemporaryriskpremiumscenario
ismorelikelytounfold.Thisdilemmaisresolvedintheothercompanionpaperalready
mentioned(McKibbinandStoeckel2009b)wherebybusinessandhouseholdsinitially
assumethepermanentviewofriskbutunexpectedlyswitchtothetemporaryscenario.

21
4.4StockMarketeffectsof apermanentversustemporaryGFC
JapanStockMarket
5.000
0.000
5.000
10.000

permanent

temporary

2020

2019

2018

2017

2016

2015

2014

2013

0.000
5.000
10.000

permanent

temporary

2020

2019

2018

2017

2016

2015

2014

2013

permanent

0
20
2

20
18

20
16

14

20

20
0

20
20

20
18

16

20

14

20

20
12

20
10

temporary

OtherAsiaStockMarket

AustraliaStockMarket
5.000
%deviation

5.000
0.000
5.000
10.000
15.000
20.000
25.000

0.000
5.000
10.000

permanent

temporary

Datasource:GCubedmodelsimulations

permanent

temporary

0
20
2

8
20
1

20
16

20
14

2
20
1

20
08

0
20
2

8
20
1

20
16

20
14

20
12

20
10

15.000
20
1

20

08

20.000

20
12

15.000

10

5.000
10.000

2.000
0.000
2.000
4.000
6.000
8.000
10.000
12.000
14.000
16.000
20

%deviation

0.000

temporary

IndiaStockMarket

5.000

20
0

2012

permanent

temporary

ChinaStockMarket

permanent

2011

2008

20
20

8
20
1

6
20
1

14

20

12

20

20
10

20.000

2010

15.000
2009

%deviation

5.000

20
08

%deviation

temporary

GermanyStockMarket

10.000
5.000
0.000
5.000
10.000
15.000
20.000
25.000
30.000

%deviation

2012

permanent

UnitedKingdomStockMarket

%deviation

2011

2008

20
20

20
1

20
16

14

20

20
12

20
10

20.000

2010

15.000
2009

%deviation

10.000
5.000
0.000
5.000
10.000
15.000
20.000
25.000
20
08

%deviation

UnitedStatesStockMarket

22
4.5Investmenteffectsof apermanentversustemporaryGFC
UnitedStatesInvestment

JapanInvestment
5.000

permanent

UnitedKingdomInvestment

%Deviation

0.000
5.000
10.000

2020

2019

2018

2017

2020

2019

2018

2017

2016

0.000
5.000
10.000

temporary

Datasource:GCubedmodelsimulations

0
20
2

20
18

20
16

14

20

20
12

permanent

temporary

0
20
2

8
20
1

20
16

20
14

2
20
1

6.000
4.000
2.000
0.000
2.000
4.000
6.000
8.000
10.000
20
08

%Deviation
0
20
2

8
20
1

20
16

20
14

20
12

temporary

OtherAsiaInvestment

10.000
5.000
0.000
5.000
10.000
15.000
20.000
25.000
20
10

10

permanent

AustraliaInvestment

permanent

20

20
0

20
20

20
18

16

temporary

20
1

permanent

20

14

20

20
12

15.000
20
10

08

15.000
20

2015

5.000

5.000

temporary

IndiaInvestment

10.000

20
0

2014

permanent

temporary

ChinaInvestment

%Deviation

2013

20
20

8
20
1

6
20
1

14

20

12

20

20
10

20
08

40.000

2012

30.000

2011

20.000

2009

0.000
10.000

10.000
5.000
0.000
5.000
10.000
15.000
20.000
25.000
30.000
35.000

2008

%Deviation

%Deviation

10.000

%Deviation

temporary

GermanyInvestment

20.000

permanent

2016

2008

20
20

temporary

2010

permanent

20
1

20
16

14

20

20
12

20
10

20
08

20.000

2015

15.000
2014

40.000

10.000

2013

30.000

2012

20.000

2011

10.000

0.000
5.000

2010

0.000

2009

10.000

%Deviation

%Deviation

20.000

23
4.6GDPeffectsof apermanentversustemporaryGFC

2019

2020
2020

2018

2017

2016

2015

2013

2014

2018

2017

2016

2014

2015

20
20

20
18

20
16

temporary

OtherAsiaGDP

1.000
%Deviation

0.000
1.000
2.000
3.000

permanent

temporary

Datasource:GCubedmodelsimulations

permanent

temporary

20
20

20
18

20
16

20
14

20
12

20
10

20
08

20
20

20
18

20
16

4
20
1

2
20
1

4.000
20
1

2013

permanent

2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000
20
0

20
14

temporary

20
12

20
0

1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000
20
1

20

20

18

20

16

20

14

20

12

20

10

20

20

%Deviation

2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000
08

%Deviation

temporary

IndiaGDP

AustraliaGDP

%Deviation

2012

permanent

temporary

ChinaGDP

permanent

2011

2010

2009

1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000
7.000

2008

2020

2019

2018

2017

%Deviation
permanent

temporary

GermanyGDP

2016

2015

2014

2013

2012

2011

2010

2009

2008

%Deviation

UnitedKingdomGDP
2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000

2012

permanent

2019

temporary

2011

2010

2008

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

permanent

0.500
0.000
0.500
1.000
1.500
2.000
2.500
3.000
3.500
4.000

2009

JapanGDP

%Deviation

3.000
2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000

2008

%Deviation

UnitedStatesGDP

24
4.7Exporteffectsof apermanentversustemporaryGFC

temporary

2020

2019

2018

2016

2015

2014

2013

2017

2020

2019

2018

2017

2016

2015

2014

2013

0
20
2

20
18

20
16

14

20

20
12

permanent

temporary

OtherAsiaExports

temporary

Datasource:GCubedmodelsimulations

permanent

temporary

0
20
2

8
20
1

20
16

20
14

2
20
1

20
1

4.000
2.000
0.000
2.000
4.000
6.000
8.000
10.000
12.000
20
08

%Deviation
0
20
2

8
20
1

20
16

20
14

20
12

10

8
20
0

temporary

5.000
0.000
5.000
10.000
15.000
20.000
25.000
20
10

20

%Deviation
20
20

20
18

16

20

14

20

20
12

20
10

20

5.000
0.000
5.000
10.000
15.000
20.000
25.000
30.000

AustraliaExports

temporary

IndiaExports

permanent

20
0

2012

permanent

temporary

4.000
2.000
0.000
2.000
4.000
6.000
8.000
10.000
08

%Deviation

2011

2010

2009

2008

%Deviation
20
20

8
20
1

6
20
1

14

20

12

20

20
10

20
08

%Deviation

4.000
2.000
0.000
2.000
4.000
6.000
8.000
10.000
12.000

ChinaExports

%Deviation

temporary

GermanyExports

6.000
4.000
2.000
0.000
2.000
4.000
6.000
8.000
10.000
12.000

permanent

2012

permanent

UnitedKingdomExports

permanent

2011

2010

2008

%Deviation
8

20
20

20
1

20
16

14

20

20
12

20
10

permanent

4.000
2.000
0.000
2.000
4.000
6.000
8.000
10.000
12.000
14.000
16.000

2009

JapanExports

8.000
6.000
4.000
2.000
0.000
2.000
4.000
6.000
8.000
10.000
20
08

%Deviation

UnitedStatesExports

25
5. Effectsofpolicyresponses
TheresultssofarhavebuiltinamonetaryreactionfunctionintheformofanHenderson
McKibbinTaylorruleforeacheconomywiththeshorttermnominalinterestrateadjustingto
avarietyoffactorsineacheconomy.Therulesassumedinthemodelhavegeneratedan
endogenousmonetaryresponsewhichissimilartothatobservedsofar.Theassumptionofan
unchangedfiscaldeficitisverydifferenttowhathasbeenobserved.Inthissectionwefocus
onannouncedfiscalresponses.TheassumedfiscalpolicychangesweregivenearlierinTable
3.7.Notethatwedonothaveinfrastructurespendinginthemodelsothatthefiscalresponses
hereareassumedtobespendingongoodsandservicesandnotgovernmentinvestmentin
physicalcapital.Expenditureoninfrastructurewouldlikelyalsostimulatemediumtolong
runsupplyinthemodelandthereforechangetheextenttowhichthereiscrowdingoutover
time.Howevertotheextentthateveninfrastructurespendingisademandstimulusforthe
firstfewyearbeforetheprojectsbegintodelivermediumrunsupplyresponses,theinitial
resultsinthisstudycanbeusedtounderstandtheshortrunimpactsofthepackages.
Effectsofthefiscalstimulusalone
Toseethemechanismsatwork,theeffectsofthefiscalstimulusaloneareshowninchartset
5.1.Theseresultsshouldbeaddedtothefinancialcrisisresultstogetapictureofthe
financialcrisis(eitherpermanentortemporary)withfiscalresponse.Indiscussingthese
resultswewilltalkaboutthemrelativetobaselinewhichcanalsobeinterpretedasrelativeto
whatwouldbeseenpostcrisis.
ThefiscalstimulusgivesaboosttorealGDPabovebaselineforallmajoreconomiesand
Chinain2009,thefirstyearofthefiscalpackages.Theeffectsareillustratedbyreferringto
China.ChinasrealGDPcouldbe1.6percentabovewhatotherwisewouldbethecasein
2009,butlittledifferentfrombaselinein2010.RealGDPwouldbebelowbaselinein2011in
Chinaastheeffectsofhigherrealinterestrateskickin.Realinterestratescouldbeover3
percentagepointsabovebaselinein2009and2010(seeappendix charts) offsettingmuchof
thedeclineinrealinterestratesfromtheglobalfinancial shockandmonetarypolicy
responses.Realprivateinvestmentis9percentbelowbaselinein2010.Consideringthe
massive11.4percentcumulativefiscalstimulusinChina,theeffectofthefiscalstimulus
aloneisquitesmall andtransitory.TheeffectonAustralia,despitethesizeofthestimulusis
amodest1.1percenthigherGDPthanotherwisein2009andGDPbelowbaselinein
subsequentyears.
NotethatthefiscalstimulusinthefirstyearraisesGDPbutforallcountriesthiseffectonly
lastsforayearandismuchsmallerthatmanycommentatorsargue.Indeedwhenaddedto
theresultsforthefullGFCsimulationthisfiscalstimulusisnotsufficienttocompletely
neutralizethecrisisinitsimpactonGDP (exceptinAustraliawheretheeconomydoesnot
enterrecessionoverafullyear).ThemainreasonforthelackofasustainedriseinGDPfrom
thefiscalpackagesinvolvestherealinterestrateimplicationsofthefiscalstimulusasshown
inAppendixchartC.6.Theglobalnatureofthestimulusimpliesaspikeupinrealinterest
rateswhichpartlyoffsetthespikedowninthefirstyearoftheshocks.Notehoweverthat

26
higherrealinterestratespersistforupto6yearsafterthestimulus.Thissuggestssome
seriousproblemstobefacedbypolicymakersduringtherecoveryperiodfrom2010onwards.
Thefiscalpackagesalsohavesignificantimpactsonglobaltrade.Inthemodel,theeffectof
fiscalpolicyontradecomesinanumberofformsoperatingboththroughincomeandrelative
priceeffects.Ifaneconomyincreasedgovernmentspending,privateconsumptiontendsto
riseandshorttermincomerises.Howevertheincreasedborrowingtendstoincreasereal
interestrates,whichreducesprivateinvestment20. Thesetworesponseshaveopposite
effectsontrade. Inparticular,durablegoodsconsumptionfallsbecauseoftheriseinreal
interestrates,whilenondurablegoodsconsumption risesduetotheincomeincrease.The
effectisthatimportsofdurablegoodsfallandnondurablesrise.Inadditionthehigherreal
interestratetendstoattractforeign capitalwhichappreciatestherealexchangerateandtends
tocrowdoutexportsandstimulatesincomethroughrelativepricechanges.Acountryacting
alonehasasubstantialchangeinthemixofthecomponentsoffinaldemand.Henceif there
isaglobalfiscalstimulus,therealexchangerate(orrelativeprice)effectsaremuted.
Howeverbecauseallcountriesareactingtherealinterestrateeffectsareaccentuatedbecause
thecallonglobalsavingsismuchlargerthantheoutcomeofanyonecountryactingalone.
Chartset5.1showsaninterestingstorywhereexportsoftheindustrialeconomiestendtofall
asaresultofthefiscalpackage.Thisoccursforseveralreasons.Firstly,becausetheOECD
economieshaverelativelylargerfiscalpackages(apartfromChina),theirrealexchangerate
willtendtoappreciaterelativetothenonOECDeconomies,crowdingoutexports.
Secondly,theseeconomiestendtoexportmoredurablegoodswhosedemandisreducedbya
riseinglobalinterestrates.Thiseffectwasalsopresentintheglobalfinancialcrisis
simulationwheretheriskadjusteddiscountriserosesharply(eventhoughrealinterestrates
fell)andthedemandfordurablegoodscollapsed.

20 To the extent that there is a substantial supply response through infrastructure, the need for interest

rates to rise for a given constrained capacity would be reduced.

%Deviation

.
2.0
1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
%Deviation

2.0
1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
%Deviation

2.0
1.0
0.0
1.0
2.0
3.0
4.0
5.0
%Deviation

%Deviation

6.0

GDP

GDP

GDP

GDP

Exports

Datasource:GCubedmodelsimulations
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

%Deviation
4.0

08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

%Deviation
2.0

20

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

0.0

08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

%Deviation
2.0

20

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

4.0

8.0

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

27

5.1GDPandexporteffectsoffiscalresponse
UnitedStates
Japan

1.0

1.0

0.0

2.0

3.0

4.0

Exports
GDP

UnitedKingdom

Exports
GDP

China

Exports
GDP

Australia

GDP

Exports

Germany

2.0
1.0
0.0
1.0
2.0
3.0
4.0
5.0

Exports

India

14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
2.0
4.0

Exports

OtherAsia

2.0
1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0

Exports

28
6. Conclusions
Thispaperhasexploredtheimpactofthreemajorshocksrepresentingtheglobalfinancial
crisisontheglobaleconomy.Forthecrisisitself threeshocksareneededtocapturethe
observeddropinassetpricesandreductionindemandandtrade.Itisnecessarytosimulate
theburstingofthehousingbubblecentredintheUnitedStatesandEurope,butextending
elsewhere,risingperceptionsofriskbybusinessasreflectedintheequityriskpremium over
bondsandrisingperceptionsofriskbyhouseholds. Thepaperhasalsoexploredthe
differencebetweenapermanentandatemporarylossofconfidence.
Thepolicyresponsehasbeen dramatic.Sotheanalysishasincludedamonetaryeasingacross
theglobeandafiscalstimulusofvaryingproportionsacrosscountriesandregions.
Simulatingtheeffectofthecrisisitself(thatisignoringthepolicyresponsesnotalreadybuilt
intothemodelsuchasendogenousmonetarypolicyrule)ontheUnitedStatesalone(the
epicentreofthecrisis)showsseveralthings.Hadtherenotbeenthecontagionacrossother
countriesintermsofriskreappraisal,theeffectswouldnothavebeen asdramatic.The
adversetradeeffectsfromtheUnitedStatesdownturnwouldhavebeenoffsettosomedegree
by positiveeffectsfromaglobalreallocationofcapital.WeretheUSaloneaffectedbythe
crisis,Chineseinvestmentcouldhaveactuallyrisen.Theworldcouldhaveescapedrecession.
WhenthereisareappraisalofriskeverywhereincludingChina,investmentfallssharply in
asensethereisnowhereforthecapitaltogoinaglobalcrisisofconfidence.Theimplication
isthatifmarkets,forecastersandpolicymakersmisunderstandtheeffectsofthecrisisand
mechanismsatwork,theycaninadvertentlyfuelfearsofameltdown andmakemattersfar
worse.
Theburstingofthehousingbubblehasabiggereffectonfallingconsumptionandimports
thandoesthereappraisalofrisk,butthereappraisalofriskhasthebiggesteffecton
investment.Risingriskcausesseveraleffects.Thecostofcapitalisnowhigherandleadstoa
contractioninthedesiredcapitalstock.Hencethereisdisinvestmentbybusinessandthiscan
goonforseveralyearsadeleveraginginthepopularbusinessmedia.Thehigherperception
ofriskbyhouseholdscausesthemtodiscountfuturelabourincomesandleadstohigher
savingsandlessconsumption,fuellingthedisinvestmentprocessbybusiness.
Whenthereisaglobalreappraisalofriskthereisalargecontractioninoutputandtrade the
scaleofwhichdependsonwhetherthecrisisisbelievedtobepermanentortemporary.The
longrunimplicationsforgrowthandtheoutlookfortheworldeconomyaredramatically
differentdependingonthedegreeofpersistenceoftheshock.Asexpected,theeffectsofthe
crisisaredeeperandlastlongerwhenthereappraisalofriskbybusinessandhouseholdsis
expectedtobepermanentversuswhereitisexpectedtobetemporary.Thisdifferenceanda
thirdscenariowhereagentsunexpectedlyswitchfromonescenariototheotherisexplored
inMcKibbinandStoeckel(2009b).Thedynamicsfor2010arequitedifferentbetweenthe
temporaryscenarioandtheexpectationrevisionscenarioeventhoughtheshocksareidentical
from2010onwards.

29
Thefiscalpolicyresponseinitiallyhasthedesiredeffectofincreasingdomesticdemandand
hencerealGDP.Whiletheboosttodomesticdemandonitsown boosts tradethereareother
effectsgoingon thathaveanadverseeffectontrade.Thefiscalstimulusandaccompanying
borrowing,causesrealinterestratestoriseoverwhattheywouldotherwisebeontopofthe
crisisthisisreturnofrealinterestratestobaselinelevels. Thiseffectwouldbedilutedifthe
globaleconomyremainedinrecessionforalongperiod.However, thenaturalrecovery from
theshocksasshownintheresultsimpliesthattherewillbecompetitionbygovernmentand
theprivatesectoroverscarcefundsforeitherprivateinvestmentortofinancefiscaldeficits.
Theriseinrealinterestrates(relativetowhattheywouldhavebeen)andfallininvestment
anddurablegooddemandimpliesthatexportsfall anddonotgetbacktobaselineforseveral
years.
AnotheraspectofthecrisisthatisexploredfurtherinMcKibbinandStoeckel(2009a)isthe
movetowardsrisingprotectionismresultingfromthelargecontractionsinglobaltrade. This
hasthepotentialtoworsentheconsequencesoftheglobalfinancialcrisis.

30
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McKibbinW.andAStoeckel(2009a)TheEffectsoftheGlobalFinancialCrisisonWorld
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31
AppendixA.Detailedresults

32
A.1Consumptioneffectsof apermanentversustemporaryGFC

2019

2020
2020

2017

2016

2015

2014

2013

2012

2018
2018

2017

2016

2015

2014

2013

20
20

20
18

20
16

20
14

20
12

8
20
0

permanent

temporary

OtherAsiaConsumption

1.000

temporary

Datasource:GCubedmodelsimulations

0.000
1.000
2.000
3.000

permanent

temporary

20
20

20
18

20
16

20
14

20
12

20
10

4.000
5.000
20
08

20
20

20
18

%Deviation
permanent

20
16

4
20
1

2
20
1

0
20
1

20
1

%Deviation
20
20

20
18

16

20

14

20

20
12

20
10

20

2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000

temporary

2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000
20
0

temporary

IndiaConsumption

2.000
0.000
2.000
4.000
6.000
8.000
10.000
08

%Deviation

2012

permanent

temporary

AustraliaConsumption

%Deviation

2011

2010

2009

2008

%Deviation
20
20

8
20
1

6
20
1

14

20

12

20

20
10

20
08

2.000
0.000
2.000
4.000
6.000
8.000
10.000
12.000

ChinaConsumption

permanent

temporary

GermanyConsumption

2.000
0.000
2.000
4.000
6.000
8.000
10.000
12.000
14.000

permanent

2011

permanent

2019

temporary

UnitedKingdomConsumption

%Deviation

2010

2008

%Deviation
8

20
20

20
1

20
16

14

20

20
12

20
10

permanent

1.500
1.000
0.500
0.000
0.500
1.000
1.500
2.000
2.500

2009

JapanConsumption

2.000
0.000
2.000
4.000
6.000
8.000
10.000
12.000
14.000
20
08

%Deviation

UnitedStatesConsumption

33
C.2Tradebalanceeffectsof apermanentversustemporaryGFC

2019

2020

2018

2017

2016

2015

2014

2013

2012

2020

%GDPdeviation

1.500
1.000
0.500

2018

2017

2016

2015

2014

2013

2012

2011

20
20

20
18

20
16

20
14

20
12

8
20
0

permanent

temporary

OtherAsiaTradeBalance

temporary

Datasource:GCubedmodelsimulations

permanent

temporary

20
20

20
18

20
16

20
14

20
12

20
10

0.500
0.000
0.500
1.000
1.500
2.000
2.500
3.000
3.500
20
08

%GDPdeviation
20
20

20
18

20
16

4
20
1

2
20
1

0
20
1

20
1

%GDPdeviation
20

20

18

20

16

20

14

20

12

20

10

20

08

20

0.500
0.000
0.500
1.000
1.500
2.000
2.500
3.000
3.500

temporary

0.500
0.000
0.500
1.000
1.500
2.000
2.500
20
0

temporary

IndiaTradeBalance

AustraliaTradeBalance

permanent

2010

permanent

temporary

0.400
0.200
0.000
0.200
0.400
0.600
0.800

permanent

2009

0.000
0.500

2008

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

%GDPdeviation

GermanyTradeBalance

ChinaTradeBalance

%GDPdeviation

temporary

2.000

permanent

%GDPdeviation

2011

permanent

2019

temporary

UnitedKingdomTradeBalance
1.600
1.400
1.200
1.000
0.800
0.600
0.400
0.200
0.000
0.200

2010

2008

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

permanent

0.400
0.200
0.000
0.200
0.400
0.600
0.800
1.000
1.200

2009

JapanTradeBalance

%GDPdeviation

1.200
1.000
0.800
0.600
0.400
0.200
0.000
0.200
0.400

2008

%GDPdeviation

UnitedStatesTradeBalance

34
C.3Realinterestrateeffectsof apermanentversustemporaryGFC
JapanRealInterestRate
1.000

2.000
3.000

2019

2020
2020

2018

2017

2016

2015

2014

2013

2012

2019

2018

2017

2016

2015

2014

2013

permanent

20
20

20
18

20
16

20
14

20
12

20
0

5.000

temporary

OtherAsiaRealInterestRate

temporary

Datasource:GCubedmodelsimulations

1.000
0.000
1.000
2.000
3.000

permanent

temporary

20
20

20
18

20
16

20
14

20
12

20
10

4.000
5.000
20
08

%pointdeviation
20
20

20
18

20
16

4
20
1

2
20
1

0
20
1

2012

2.000
3.000
4.000

20
1

%pointdeviation
20

20

18

20

16

20

14

20

12

20

10

20

20
8

temporary

1.000
0.000
1.000

temporary

2.000
1.000
0.000
1.000
2.000
3.000
4.000
20
0

temporary

IndiaRealInterestRate

1.000
0.000
1.000
2.000
3.000
4.000
5.000
08

%pointdeviation

2011

permanent

temporary

AustraliaRealInterestRate

%pointdeviation

2010

2008

%pointdeviation
2020

2019

1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000
7.000
8.000

ChinaRealInterestRate

permanent

2011

permanent

GermanyRealInterestRate

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

%pointdeviation

permanent

permanent

2010

2008

temporary

UnitedKingdomRealInterestRate
2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000
6.000

2009

4.000
5.000

2020

2019

2018

2017

0.000
1.000

2009

permanent

2016

2015

2014

2013

2012

2011

2010

2009

%pointdeviation

2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000

2008

%pointdeviation

UnitedStatesRealInterestRate

35
C.4Realeffectiveexchangerateeffectsof apermanentversustemporaryGFC

%Deviation

2019

2020
2020

2018

2017

2016

2019

2018

2017

2016

2015

2014

2013

1.500
1.000
0.500
0.000

20
20

20
18

20
14

20
16

temporary

OtherAsiaRealExchangeRate

temporary

Datasource:GCubedmodelsimulations

permanent

temporary

20
20

20
18

20
16

20
14

20
12

20
10

3.000
2.000
1.000
0.000
1.000
2.000
3.000
4.000
5.000
20
08

%Deviation
20
20

20
18

20
16

4
20
1

2
20
1

20
12

permanent

2.500
2.000
1.500
1.000
0.500
0.000
0.500
20
1

temporary

AustraliaRealExchangeRate

permanent

20
1

20
0

20

20

18

20

16

20

14

20

12

20

10

0.500
20

08

20

2012

2.000

permanent

temporary

IndiaRealExchangeRate

1.000
0.000
1.000
2.000
3.000
4.000
5.000

20
0

2011

permanent

temporary

ChinaRealExchangeRate

%Deviation

2010

4.000
2.000
0.000
2.000
4.000
6.000
8.000
10.000

2008

%Deviation
2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2008

2009

%Deviation

2.000
3.000
4.000
5.000

%Deviation

temporary

GermanyRealExchangeRate

1.000
0.000
1.000

permanent

2015

permanent

UnitedKingdomRealExchangeRate

6.000

2014

20
20

temporary

2009

permanent

20
1

20
16

14

20

20
12

20
10

20
08

25.000

2013

20.000

2012

15.000

2011

5.000
10.000

2.000
1.500
1.000
0.500
0.000
0.500
1.000
1.500
2.000
2.500

2008

0.000

%Deviation

%Deviation

5.000

2010

JapanRealExchangeRate

2009

UnitedStatesRealExchangeRate

15.0

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

10.0

5.0

0.0
5.0

5.0

10.0

Datasource:GCubedmodelsimulations

20.0

2019
2020

2020

2020

2016

2020

2015

2014

2013

2019

2015

2014

2012

2011

2010

2009

2019

15.0

2018

10.0
2019

0.0

2017

5.0
2018

OtherAsiaInvestment
2018

6.0

2018

4.0

2016

0.0
2017

2.0

2017

2.0

2017

IndiaInvestment
2016

2015

2014

2013

2013

2012

2011

GermanyInvestment

2016

2015

AustraliaInvestment

2014

8.0

2013

ChinaInvestment

2012

8.0

2012

6.0

2011

4.0

2011

0.0

8.0
6.0
4.0
2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
2010

UnitedKingdomInvestment

2010

2.0
2008

UnitedStatesInvestment

2010

4.0

2009

10.0

2008

%Deviation

0.0

2009

2.0

%Deviation

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

5.0

2009

%Deviation

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2008

%Deviation
5.0

6.0
4.0
2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0

2008

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2009

2008

%Deviation
10.0

2008

10.0

%Deviation

4.0
2.0
0.0
2.0
4.0
6.0
8.0
10.0
2008

10.0

2009

%Deviation
15.0

2008

%Deviation

36

C.5Investmenteffectsoffiscalresponse
JapanInvestment

%pointdeviation

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

%pointdeviation

3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
0.5

2009

Datasource:GCubedmodelsimulations
0.2

AustraliaRealInterestRate

3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
0.5
2017
2018
2019
2020

2019

2020

2016

2015

2018

OtherAsiaRealInterestRate

2017

2016

ChinaRealInterestRate

2014

0.0

2015

0.5

2013

0.5

2014

1.0

2012

1.5

2013

2.5

2011

UnitedKingdomRealInterestRate

2012

0.5

2010

0.0

2011

0.5

2009

1.0

2010

2.5

2008

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

3.0

2.5

%pointdeviation

1.5

08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

2.0

%pointdeviation

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

%pointdeviation
2.0

20

%pointdeviation

UnitedStatesRealInterestRate

2009

%pointdeviation

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

3.0

2008

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
0.5

2008

%pointdeviation

37

C.6Realinterestrateeffectsoffiscalresponse
JapanRealInterestRate

2.0

1.5

1.0

0.5

0.5

0.0

GermanyRealInterestRate

4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
0.5

IndiaRealInterestRate

1.0

0.8

0.6

0.4

0.2

0.0

0.4

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

0.0

0.2

Datasource:GCubedmodelsimulations

0.5
2016

2015

2014

2013

2012

2020

0.0
2019

0.5

2020

1.0
2018

1.5

2019

2.0
2017

2.5

2018

OtherAsiaTradeBalance

2017

2016

0.2

2015

0.4

2014

AustraliaTradeBalance

2013

ChinaTradeBalance

2011

UnitedKingdomTradeBalance

2012

0.5
2010

0.5

2011

0.4

2009

UnitedStatesTradeBalance

2010

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

0.3

08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

0.2

%GDPDeviation

0.0

20

0.1
0.1
0.0
0.1
0.1
0.2
0.2
0.3
0.3
0.4
0.4
%GDPDeviation

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

%GDPDeviation
0.1

2008

%GDPDeviation

%GDPDeviation
0.1

2009

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

0.2

2008

0.6

%GDPDeviation

%GDPDeviation
0.4
0.2
0.0
0.2
0.4
0.6
0.8
1.0

2008

%GDPDeviation

38

C.7Tradebalanceeffectsoffiscalresponse
JapanTradeBalance

0.1
0.1
0.0
0.1
0.1
0.2
0.2
0.3
0.3
0.4

GermanyTradeBalance

0.2

0.2

0.0

0.4

0.6

0.8

1.0

IndiaTradeBalance

2.0

1.5

1.0

0.5

0.0

39
C.8Realeffectiveexchangerateeffectsoffiscalresponse
JapanRealEffectiveExchangeRate

8.0

1.0

6.0

0.5

%Deviation

4.0
2.0
0.0

0.0
0.5

4.0

1.5
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

1.0

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

2.0

UnitedKingdomRealEffectiveExchangeRate

GermanyRealEffectiveExchangeRate

1.0

0.6
0.4
0.2
0.0

20

20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

0.2

3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
0.5
1.0
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20

%Deviation

Datasource:GCubedmodelsimulations

2019

2020
2020

2018

2019

2017

2016

2015

2014

0.0
0.5
1.0

2018

2017

2016

2015

2014

2013

2012

2.0

2011

1.5
2010

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

%Deviation

0.5

2008

%Deviation

2013

OtherLDCRealEffectiveExchangeRate

LatinAmericaRealEffectiveExchangeRate

0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0

2012

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

0.0
0.5

2011

0.5

2010

1.0

0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2

2009

%Deviation

1.5

2008

%Deviation

2.0

2008

IndiaRealEffectiveExchangeRate

ChinaRealEffectiveExchangeRate

2009

%Deviation

0.8

2008

%Deviation

UnitedStatesRealEffectiveExchangeRate

www.lowyinstitute.org