Perspectives on Emerging Economies Growth Vincenzo D’Apice Observatory on Emerging Economies, Luiss 22-Feb-2011

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice 1.A framework for Boom & Bust Cycles: The Minsky Model 2.Perspectives on Emerging Market Economies Growth Agenda

Starting Point: -Low inflation -Low unemployment Positive Shocks: -Deregulation -Financial innovation -Capital inflows Banking Sector: -Demand for credit rises -Risk underestimation -Supply of credit rises Financial Markets: -Asset prices rise (shares & real estate) -Wealth increases -Debt increases Real Economy: -Consumption rises -Investment raises -Lower savings -Rising current account deficit Boom: -Economy overheats -Real and/or financial imbalances grow -Financial structure becomes fragile Politicians & economists theorize the beginning of a new Era (e.g. New Economy) Balance sheet channel Lending channel Financial accelerator (Bernanke-Gertler,’95) Animal spirits (Keynes 1937) Global Imbalances (Bernanke ’07) -Covered -Speculative -Ponzi The Great Moderation (Bernanke ’04) The Minsky modelBoom stage Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice

Starting Point: -Rising interest rates -Sudden change in expectations Negative Shocks: -Capital flows away from more speculative investment Banking Sector: -Pessimistic evaluation of risk -Demand for credit falls -Supply of credit falls (crunch) Financial Markets: -Asset prices fall -Wealth falls -Debt deflation -Real debt increases Real Economy: -Consumption falls -Investment falls -Rising savings -Lower current account deficit Bust: -Banking crisis (bank runs) -Recession Debt Spiral a la Fisher 1933 Deflationary Spiral -Central Bank -Government -Regulation Default of Ponzi units Minsky modelBust stage Vincenzo D’Apice Observatory on Emerging Economies, Luiss, 22 Febbraio 2011

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice The outlook is: U-shaped recovery in advanced economies V-shaped recovery in emerging-market countries What is the Outlook for the Global Economy?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice The role of EEs will be even stronger in the next decade (BRICs + N-11): $37t $27t $10t 45% 30% What Will Be the Role of Emerging Economies?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice One of the more striking story will be the rise of the new BRICs middle class: Import of low value added goods Import of high value added goods (car, technology) 2010 middle-class consumers purchasing power $7 trillion 2020 middle-class consumers purchasing power $20 trillion * What Will Be the Role of Emerging Economies?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice The first risk is further financial contagion in Europe: What Are the Downside Risks in This Scenario?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice The second risk is the negative effects of Fed QE: FED QE * is subjecting the emerging economies to a flood of capital, rising commodity prices, inflation, and (possibly) asset bubbles: What Are the Downside Risks in This Scenario?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice The third risk is that capital inflows to emerging markets will be mismanaged, thus fueling credit and asset bubbles: Capital Flows to Emerging Markets (% of world GDP) Capital Flows to Emerging Markets (% of world GDP) Net liabilities6,5%1%4% Drivers: Asset allocations Carry trades What Are the Downside Risks in This Scenario?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice Flows into debt and equity mutual funds have been strong: Risk of asset price bubbles So, back to the twin crises of 90s? Yes & No Yes, b/c the bust of the bubble can trigger a banking crisis No, b/c the risk of currency crisis is low thanks to the accumulation of intl. reserves Annual Retail Flows to Emerging Market Debt and Equity Mutual Funds ($ billion) What Are the Downside Risks in This Scenario?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice The fourth risk is inflation in emerging markets: What Are the Downside Risks in This Scenario?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice The fifth risk is currency tensions (currency war): Global imbalances will remain large Deficit countries need a currency depreciation But, surplus countries don’t want to accept a currency appreciation Global Imbalances (% of world GDP) Deflation in deficit countries Higher risk of debt default (via Fisher spiral) What Are the Downside Risks in This Scenario?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice The sixth risk is geopolitical (Korea, Pakistan, Tunisia, Egypt, Libya). This risk is putting pressure on the price of commodities: This, in turn, will put further pressure on inflation What Are the Downside Risks in This Scenario?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice For example, the shadow banking system is still “shadow”: $16t $13t By the Way, Don’t Forget the Causes of the Recent Crisis

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice EEs Strong Growth Rising Middle- Class EU Debt Crisis Fed QE Capital Inflows Inflation Global Imbalances Geo- Political Emerging Banking System Why Do We Need Monitoring the Emerging Banking Systems?

Observatory on Emerging Economies, Luiss, 22 Febbraio 2011 Vincenzo D’Apice Thank You Contacts: Vincenzo D’Apice