Financial and Economic Crisis: Transmission Channels and Impacts

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Financial and Economic Crisis Transmission
Channels and Impacts

• Randy Spence
• PEP Forum on
• The Impact of the Global Financial Crisis
• Manila, Feb. 17 2009
• For Discussion

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Contents

• International Transmission Channels
• Domestic Transmission
• Micro Impacts
• Poor and Disadvantaged Populations
• Coping Mechanisms
• Mitigation Measures
• All in broad brush only the next 2 days
  will fill in much more detail

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International Transmission Channels

• Portfolio investment plummets
• bonds and stocks held, short term credit provided
  from foreign to local banks
• almost immediately after peak (October) of
  financial crisis
• de-leveraging of Western/OECD banks
• outflows of capital in most other countries
• large exchange rate fall

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Indian Rupee
5
Philippine Peso
6
Kenya Shilling
7
Peruvian Nueva Sol
8
Chinese Yuan
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International Transmission Channels

• And as economies begin to contract
• Exports decline
• and imports, given exchange rates
• net change (X-M) could be or (likely -)
• Foreign Direct Investment falls
• net flow may reverse as multinationals de-lever
• plant closure and job loss quite quickly
• Remittances fall
• where foreign workers lose jobs / return
• where the foreign currency depreciates more

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International Transmission Channels

• Tourism declines
• AID declines overall
• ODA, other official flows, NGO/voluntary flows
• Knowledge flows decline
• both proprietary IP flow (in and outside FDI)
• and open knowledge investment / content
• Reinforcement capital outflows continue as
  domestic economy declines

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Domestic Transmission

• What has been hit?
• Credit and bank / financial system liquidity
• Investment initially mainly foreign
• Remittances
• Exports
• Tourism and AID
• Large cumulative effect on exchange rates
• Large immediate welfare loss
• Complexities which exchange rates, trade
  partners..?

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Domestic Transmission

• Panic domestically originated de-leveraging
• credit and liquidity banks de-lever and market
  investors move to safer ground
• real investment falls as firms shelve plans
• consumption falls as consumers save
• government spending left to fill expenditure
  gap, as well as rescue the financial system
• Drop in consumption, equity investment, real
  investment, sales, production, jobs and incomes

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Domestic Transmission

• Remembering that financial system impacts
  continue, reinforce real impacts in C, I, G,
  X-M
• Keynesian terms
• If expenditure CIG (X-M) initially falls 4,
  due to falls in exports, tourism, remittances,
  FDI, AID
• End-effect is 10 if multiplier is 2.5
• Indonesia in Indonesia crisis 17 loss of GDP,
  back to initial level in 3-4 years
• This is my current best guess about present crisis

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Micro Impacts

• Can lower-level (micro) impacts be projected?
• sector, region production, employment, incomes
• household income, employment, health, security
  etc.
• And is it essential to do this?
• compared to focus on monitoring and mitigating?
• put another way, if the situation of HH is
  monitored, how much more is gained by knowing
  why and how as well as what has happened to
  (poor) people?
• My answer (below) has mostly to do with targeting

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Micro Impacts

• GE approach is tempting
• but CGE models probably impossible to adapt to
  this wide a range of financial, quantity and
  price shocks
• lack of CGE analysis of other financial crises
  (Asia Crisis) seems to support this view
• Each country will be different in terms of
  sectors hit hardest because of
• different importance of sectors in the economy
• different exposure of sectors to international
  and domestic transmission mechanisms

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Micro Impacts

• Some partial equilibrium analysis likely useful
• projecting and tracking main immediate impacts
  (follow the money)
• identifying where to look for the big micro
  impacts
• For example
• financial sector/workers, export industries
• remittance-dependent populations
• foreign-company workers, tourism sector/workers
• commodity producers, luxury goods/services
  suppliers

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Micro Impacts

• Why is it useful to predict micro impacts, as
  opposed to simply monitoring them?
• for selection of sites to monitor, given that (in
  CBMS), full country coverage wont be feasible
• for survey indicators and questions
• for choice and design of mitigation policies and
  interventions
• Knowing what is more important than knowing
  why, (my view) and there are real limits to
  knowing why with so many transmission channels

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Poorer Populations

• What about impacts on the poor and BoP?
• To what extent are poor population groups
  decoupled from the market economy?
• From a HH view what can decline or disappear?
• markets/sales agriculture, informal production,
  services (incl. tourism), jobs and intermittent
  work
• public and social services security, health,
  education..
• prices net effect of deflation on incomes
  purchases
• remittances, credit to survive, etc.

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Poorer Populations

• Gender impacts and impacts on children (UNICEF)
• women are typically poorer across and within HH
• complex reasons, but well studied in general
  (non-crisis) conditions
• CBMS in many countries is capable of gender and
  age differentiated monitoring this should be
  done
• CBMS monitoring strategies to consider gender
  childrens issues in their design (next 2 days)

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Coping Mechanisms

• The range of mechanisms recently studied for the
  food crisis provides a good reference point
• Food and nutrition
• reducing consumption, cheaper foods and sources
  etc.
• Fuel, electricity and water
• cheaper fuels (wood, less cooking etc.
• Education
• children withdrawn from school, moved from
  private to public schools etc.

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Coping Mechanisms

• Health
• reduction in seeking services, substitution of
  public and traditional for private, traditional
  and generic medicines for branded, etc.
• Communications and transport many forms
• Savings reduction, drawing on savings
• Selling pawning assets productive and other
• Incomes multiple jobs, borrowing (if possible)
  etc.
• Substitution of necessities for luxuries (travel,
  entertainment recreation etc.)

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Coping Mechanisms

• Often a fine line between coping simply being
  poorer reducing food intake when already
  malnourished
• Poor HH have fewer coping mechanisms available
• Women typically have fewer coping options, or
  have coping options which undermine their health
  wellbeing more
• again the importance of gender differentiated
  monitoring
• Dependency ratios and relationships important

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Mitigation Measures

• In terms of the CBMS initiative, probably we are
  looking mostly at safety nets
• but an eye to generation of (local) economic
  activity, longer term economic development will
  be useful
• crisis can be a good time to accomplish
  structural changes and reforms - carefully
• Some dimensions of safety net targeting
• general (cash transfers) and more purposeful
  (health insurance, education incentives)

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Mitigation Measures

• general (stimulus) and location-specific (hard
  hit areas)
• shorter and longer term e.g. children who leave
  school tend not to go back keeping kids in
  school is a long term investment, and very useful
  in a crisis
• Monitoring should be over several years, and
  ideally for the same sites
• those who suffer are often NOT those who gain
  during recovery
• Mitigation assistance for long term victims

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Mitigation Measures

• Financing mitigation measures
• Many in society do not lose, even gain (e.g. from
  secure jobs/incomes and lower prices)
• Tax the secure and take care of the victims
  (Robin Hood model) but tax increases are
  contractionary
• So run deficits and take care of the victims
  but typically limits to Govt. borrowing in crisis
  times
• International financing mechanisms important - a
  trusted IMF with enough resources, W.B., regional
  development banks etc.

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Mitigation Measures

• A good time for Liberal economic policy
• For small open economies, best survival paths are
  mainly matters of redistribution
• Supporting efficient redistribution is not only
  (as always) the right thing to do
• It also may benefit you, as very few jobs and
  incomes are completely secure
• A well designed CBMS initiative can be very
  helpful in achieving efficient redistribution and
  economic security