NORDICS IN GLOBAL CRISIS

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Chastity Thompson
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1 AM H? OT 0 NORDICS IN GLOBAL CRISIS Vulnerability and resilience Thorvaldur Gylfason, Bengt Holmstrom, Sixten Korkman, Hans Tson Soderstrom, Vesa Vihriala The Research Institute of the Finnish Economy (ETLA) Publisher: Taloustieto Oy

2 CONTENTS PREFACE THE AUTHORS 1 INTRODUCTION AND SUMMARY: PUTTING THE CRISIS INTO PERSPECTIVE Panic strikes: Was the Great Moderation a Great Illusion? Bashing bankers is not enough: The macroeconomics of lopsided globalization The Great Stabilization prevented a repetition of the Great Depression Regulation and stabilization: Do we need more? Some economies suffered more than others Lessons from Nordic experiences The world needs a more robust financial system Exchange rate flexibility is no panacea The EMU is increasingly subject to strains Fiscal policy may not be all that powerful but it is still essential We need both growth and fiscal consolidation The Nordic model is both vulnerable and resilient 28 Endnotes 32 2 THE CRISIS AND THE GLOBAL POLICY RESPONSE The downturn was exceptionally sharp and synchronized Unprecedented policy response The US and the EU are different, but is there (some) convergence? Was the global policy response effective? Time for exit? 48 Endnotes 51

3 3 THE PANIC OF : A MODERN BANK RUN The emergence of shadow banking Global imbalances in demand and supply of assets The magic of securitization and structured finance The shadow banking system complex intermediation chains The repo market as surrogate banking Haircuts and leverage The panic Was lack of transparency the problem? So what happened and what is the future of shadow banking? 75 Endnotes 77 4 LOOKING BACK AT VOLATILITY AND GROWTH The Great Depression and other avoidable slumps The confluence of stabilization and regulation Continental Europe: Similar story Nordic countries: More of the same Growing together ' Learning from history 95 Endnotes 98 5 DEjA VU: THE CRISIS OF SWEDEN AND FINLAND IN THE EARLY 1990s Two different policy approaches converge in financial liberalization Financial liberalisation without stabilization creates an unsustainable boom External shocks trigger a bust Monetary easing, fiscal expansion and massive bank support Swift handling of the banking crises Lessons learnt This time is similar - and very different 114 Endnotes 118

4 SAFEGUARDING FINANCIAL INTERMEDIATION: NORDIC LESSONS Problems must be recognised before action can be taken Maintaining confidence is key and requires a solid framework for crisis management There are many ways to support confidence Asset disposal strategy and rationalisation deserve substantial attention '., Saving the intermediaries is not enough 133 Endnotes 135 FROM BOOM TO BUST THE ICELAND STORY First to freeze Lopsided liberalization Privatization among friends Increased inequality and other signs Enter the IMF Checks and balances, and trust Prospects Eleven lessons 162 Endnotes 165 EMU AND THE CRISIS: BETTER TO BE IN OR OUT? Why Finland joined the euro and why Sweden did not The euro in its first decade The euro has made little difference for Finland and Sweden so far The crisis and exchange rates: Why did the Swedish krona weaken so much? Does depreciation help? The weak krona: Will Sweden benefit? Is Sweden pursuing a "beggar-thy-neighbour" policy? What about Denmark and the euro? Conclusions on the monetary regime 194 Endnotes 196

5 9 CAN FISCAL POLICY HELP? Is fiscal policy effective? Fiscal policy in the euro area 204 Endnotes FISCAL CONSOLIDATION AND GROWTH Cutting expenditure and strengthening the tax base More growth through lower taxes? v._ Endnotes BUILDING A MORE ROBUST FINANCIAL SYSTEM Excessive leverage and risk taking Lines of action in financial regulation and supervision The importance of macroeconomic policy 240 Endnotes VULNERABILITY AND RESILIENCE Stop the world? Some were harder hit than others Less vulnerability More resilience A crisis of the Nordic model? A global economy needs more than local policies 257 Endnotes 259 References 260

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