Carsten Jung, Theresa Löber, Anina Thiel and Thomas Viegas
Governments have pledged to meet the Paris Target of restricting global temperature rises to ‘well below’ 2˚C. But reducing CO2 emissions and other greenhouse gases means reallocating resources away from high-carbon towards low-carbon activities. That reallocation could be considerable: fossil fuels account for more than 10% of world trade and around 10% of global investment. In this post, we consider the macroeconomic effects of the transition to a low-carbon economy and how it might vary across countries. While much of the discussion has focussed on the hit to economic activity and the potential for job losses in higher-carbon sectors, we highlight that the transition also offers opportunities. And the overall impact depends crucially on when and how the transition takes place.
Benjamin Guin and Perttu Korhonen
A well-insulated house reduces heat loss during cold winter periods and it keeps outdoor heat from entering during hot summer conditions. Hence, effective insulation can reduce the need for households to use cooling and heating systems. While this can lower greenhouse gas emissions by households, it also reduces homeowners’ energy bills, which can free up available income. This can protect households from unexpected decreases in income (e.g. reduced overtime payments) or increases in expenses (e.g. healthcare costs). It could also help homeowners to make their mortgage payments even if such shocks occurred. But does this also imply that mortgages against energy-efficient properties are less credit-risky?
Small, young private firms in China have long been struggling to obtain formal bank loans. To bypass financial constraints, these firms have resorted to alternative, less formal financing sources. In this context, Chinese authorities are aiming to develop a more formal, market-based, and better regulated credit sector. In a Staff Working Paper, I argue that carefully designed credit sector reforms are crucial to avoid throwing out the baby with the bath water. Despite the interest rate liberalisation progressively implemented by Chinese authorities, a general crackdown on alternative finance would remain detrimental to the dynamism of small enterprises. Selectively tightening the limits around informal financing could better balance financial stability on the one hand, and welfare and efficiency on the other.
For the global economy, it was the best of times, and then it was the worst of times. Buoyed by very strong growth in emerging markets, the global economy boomed in the mid-2000s. On average, annualised world GDP growth exceeded 5% for the four years leading up to 2007 – a pace of growth that hadn’t been sustained since the early 1970s. But it wasn’t to last. In this post, I illustrate how the failure of Lehman Brothers in September 2008 coincided with the deepest, most synchronised global downturn since World War II. And I describe how after having seen the fallout of the Lehman collapse, macroeconomic forecasters were nevertheless surprised by the magnitude of the ensuing global recession.
Neeltje van Horen
Cross-border bank lending fell dramatically in the aftermath of Lehman Brothers’ failure as funding constraints forced banks to reduce their foreign exposures. While this decline was partly driven by lower demand for international bank credit, it was substantially aggravated by a retrenchment of international banks from cross-border lending. But banks did not cut their cross-border lending in a uniform manner. Instead, they reallocated their foreign portfolios towards countries that were geographically close, in which they had more experience, in which they had close connections with domestic banks or in which they operated a subsidiary. The crisis thus showed that deeper financial integration is associated with more stable cross-border credit when large global banks are hit by a funding shock.
Sterling money markets are a critical part of the plumbing of the UK financial system. They act as the main conduit for short-term borrowing and lending between banks, and a whole range of other institutions, financial and non-financial. And the ebb and flow of activity in sterling money markets is also crucial to the Bank of England as the first stage in the transmission mechanism of monetary policy, linking changes in the Bank’s policy rate – Bank Rate – to activity and prices in the wider economy. So when things go wrong in this market, as they did during the financial crisis, the effects reach into every part of the UK economy and, given the significant role of international banks in London, beyond. So what happened in the autumn of 2008, and why?
Johnny Elliot and Benjamin King
In August 2007 problems were emerging in the US sub-prime mortgage market. Rising numbers of borrowers were getting behind on their repayments, and some investors exposed to the mortgages were warning that they were difficult to value. But projected write-downs were small: less than half a percent of GDP. Just over a year later, Lehman Brothers had failed, the global financial system was on the brink of collapse and the world was plunged into recession. So how did a seemingly small corner of the US mortgage market unleash a global crisis? And what lessons did the turmoil of autumn 2008 reveal about the financial system?
The collapse of Lehman Brothers in September 2008 will forever be remembered as a pivotal moment in the global financial crisis. TV pictures flashed around the world of staff carrying their belongings out of their offices as their employer filed for bankruptcy. But few observers watching at the time foresaw the tumultuous events that would be unleashed in the weeks and months that followed. And the consequences endured: for policymakers, academics and market participants alike, the world was never quite the same again.
In this special series of posts, we turn the clock back to 2008 to look at how the crisis unfolded and what those events revealed about the economic and financial system. This week, we’ll publish four posts, each focussing on a different aspect. Today’s opening post explores how trouble in the subprime US mortgage market ended up creating a global emergency. Subsequent posts will look at the sharp contraction in cross-border lending, the turmoil in money markets, and knock-on effects on the global economy.
The authors take a diverse range of approaches- some draw on earlier academic work, some focus on the evolution of the data, others try to piece together the mechanics of the system. As ever, we welcome your discussion of our work- either using the comments facility at the foot of each post, tagging @BoE_Research on twitter or best of all – via by writing a response on your own blog!
John Lewis, Managing Editor