Charles Bean: Rebalancing
Speech by Mr Charles Bean, Deputy Governor for Monetary Policy of the Bank of England,
at the Official Monetary and Financial Institutions Forum Golden Series Lecture, London,
29 May 2013.
* * *
Good morning! It is almost six years since the onset of the Global Financial Crisis and almost
four years on from the trough of the recession that followed the collapse of Lehman's. Yet
despite highly stimulatory monetary policies, we are still a long way short of seeing a full
recovery in the advanced economies. Here, output remains some 21⁄2% below its pre-crisis
peak, while in the euro area the shortfall is even larger at 31⁄4%. And even in the United
States, where the recovery is further advanced, output is just 31⁄4% above its pre-crisis peak,
well below where one might have expected on the basis of past cyclical recoveries.
That sluggishness in the recovery reflects the fact that, unlike a normal cycle, substantial real
adjustments are also required in our economies. These include not only the repair of
overextended balance sheets, especially in the banking sector, but also the need to shift the
composition of demand and production towards more sustainable patterns. And these shifts
require changes not only in the indebted countries, but also corresponding shifts in the
pattern of demand and production in other countries. To what extent are these changes
under way?
Let me begin with our own rebalancing challenge, here in the United Kingdom. The pre-crisis
decade was generally one of steady growth and inflation close to the target, and thus few
signs of overheating in the real economy. Domestic demand nevertheless consistently
outstripped the supply of output, generating a small but persistent current account deficit,
averaging around 2% of GDP. MPC members noted on several occasions that this would
have to be corrected at some stage, and would most probably need to be accompanied by a
lower sterling real effective exchange rate.1
Such a rebalancing process appeared to have been set in train by the deterioration in the
outlook and the rise in uncertainty associated with the financial crisis. Household spending
collapsed, as the saving ratio rose from around 1-2% to around 7%, with much of the rise
accounted for by the behaviour of highly indebted households (Chart 1); businesses' capital
spending also fell sharply, though that is something we would like to have seen more of,
rather than less. At the same time, sterling fell by a quarter. That should have given us a
head start in crowding in net exports to replace the lost domestic demand. The performance
of net exports has, however, been distinctly underwhelming, adding just 11⁄2 percentage
points to total growth since the start of the recession. That is not simply a reflection of the
weakness in our export markets, as the weakness at home has depressed imports
correspondingly. Once one controls for the changes in activity at home and abroad, net
exports still look weak.
Imports and exports of goods have, however, behaved pretty much as expected. For
example, the decline in our share of the market for exports of goods appears to have been
halted (Chart 2). The real disappointment has instead been in exports of services, where our
market share - which had been rising strongly before the crisis - has flattened off, rather
than accelerating. A large part of that reflects a decline in the demand for financial services
globally as a result of the crisis, but that alone is not sufficient to explain the weakness. Along
with the surprising robustness of employment, the disappointing performance of net trade is
yet another puzzling aspect of this particular downturn. One possibility is that the lags have
been elongated, perhaps because heightened uncertainty has inhibited the necessary
investment to move into new markets. If that is the case, then net exports can be expected to
perform better as recovery here and abroad proceeds. But another possibility is that the
demand for, and supply of, exports have become less responsive to relative price signals,
perhaps reflecting the nature of the goods and services we have a comparative advantage
in. That would imply a less optimistic outlook.
Let me now venture further afield, to the euro area. The euro area is by far our largest trading
partner - accounting for getting on for half our exports - and those direct links are
supplemented by close financial ties between our domestic banking system and the
continent. So it is hardly surprising that recent Inflation Reports have singled out
developments in the euro area as a key risk to the UK outlook.
Although the euro area has been in rough current account balance since the introduction of
the euro, there have of course been substantial intra-zonal imbalances. In the run up to the
crisis, periphery countries ran persistent current account deficits financed in large part by
borrowing from core countries, especially Germany. As a result, the net international
investment position of Spain has deteriorated by around 60% of (annual) GDP since 2000,
while for Greece and Portugal the number rises to around three quarters of GDP (Chart 3).
On the other side, Germany's net international investment position has improved by around
40% of GDP.
Initially these imbalances were seen as the benign consequence of an underdeveloped
periphery catching up with a richer core. But on top of that were less benign influences. First,
perceptions of supply potential in the periphery appear to have been over-optimistic;
subsequent revisions to the IMF's estimates of spare capacity bear witness to that (Chart 4).
Second, credit conditions loosened substantially, supported by a sharp compression in
perceived long-term risk-free rates, which was only unwound when markets began re-pricing
in the risk of bank and sovereign default in the periphery (Chart 5). The decline in interest
rates in the periphery in the pre-crisis period suggests that it was a case of capital being
pushed into the periphery, rather than it being sucked in by a high rate of return as
conventional analysis would suggest. The consequence of all this was an increase in
demand in the periphery, much of it in construction, financed by borrowing from the core.
This is illustrated in the contrasting experiences of Spain and Germany. Domestic demand in
Spain consistently outstripped output growth pre-crisis, while the opposite was true in
Germany (Chart 6). These growing external imbalances were accompanied by increasing
internal imbalances, as the non-tradable sector in Spain expanded at the expense of the
tradable sector, driving up unit labour costs in the former relative to the latter (Chart 7). That
was not the case in Germany.2
Restoring the euro area to strong and balanced growth requires dealing not only with the
accumulated financial imbalances - the excessive banking and sovereign debts in the
periphery - but also restoring competitiveness and rebalancing the structure of demand and
production. On the face of it, that rebalancing is under way, with a narrowing in the current
account deficits of the periphery. Chart 8 indicates, however, that much of that is attributable
to the substantial fall in imports associated with the collapse in domestic demand, rather than
a rise in exports (although to the extent that there was excess demand before the crisis - as
Chart 4 suggests - part of that decline in imports will be warranted).
Moreover, the necessary sectoral reallocation of resources is harder to achieve in a currency
union than in a country with its own currency, as the exchange rate is not free to adjust to
expedite the necessary adjustments in prices and quantities. Absent a supply-side miracle to
raise productivity in the periphery, the necessary reversal in the movements in relative unit
labour costs needs instead to come about through wage and price adjustment, which may
require a sustained period of spare capacity in the periphery together with excess demand in
the core.
There is, however, an inherent asymmetry, noted long ago by Keynes, that when credit flows
dry up, adjustment is compulsory for the debtor but only voluntary for the creditor. Moreover,
not only does the creditor lack the urgent need to adjust, they may also feel that the debtor
ought to bear more of the burden of adjustment on moral grounds. Consequently the
pressure for austerity is greater in the periphery, than it is to boost demand in the core. So,
while the euro-area authorities have been making substantial progress in constructing the
economic architecture to support the monetary union, the adjustment process taking place in
the periphery is nevertheless likely to continue to weigh on euro-area demand prospects for
some time. And that will also act as a headwind to the recovery here in the United Kingdom.
Let me turn finally to the global picture. During the build-up to the financial crisis, significant
international payments imbalances emerged (Chart 9). On one side were the advanced
economies, most especially the United States, running large and persistent current account
deficits. On the other side were the emerging economies - most notably in Asia - and latterly
the oil exporters, showing large current account surpluses. In the decade prior to the financial
crisis, for example, the US current account deficit widened from under 2% of GDP to 5%,
while the surplus in China rose from 4% of GDP to 10%.
That constellation of international payments flows, with emerging economies exporting
capital to advanced economies, was the opposite of what conventional economic models
would predict. Normally one would expect countries in the catch-up phase of economic
development with temporarily high investment levels to import the necessary savings from
overseas. But a combination of limited household safety nets and under-developed domestic
financial markets generated unusually high private savings rates. In addition, some emerging
economy governments engaged in the accumulation of foreign reserves, in order both to
sustain export-led development and to insure against sudden capital outflows of the sort
seen in 1997-8. So capital flowed uphill, rather than downhill as in the euro area. Moreover,
there was a strong desire to hold these savings in safe assets, such as US Treasuries.
The counterpart to this "savings glut" was downward pressure on the interest rates on those
safe assets in the advanced economies. Faced with these lower returns on safe assets,
investors then sought to generate higher returns in other ways, including packaging
securities in ways that appeared to combine yield with safety. And a long period of benign
economic outcomes - the Great Moderation - lulled investors into a false sense of security.
The consequent buoyancy in asset prices and easy availability of credit then helped sustain
demand. But all this came to an end when investors realised the true nature of their
exposures, leading to a scramble for safety, a drying-up of credit and a sharp reduction in
spending by households and businesses.
net
This analysis focuses on the capital flows between countries, but in passing it is worth
noting that gross capital flows can be just as, if not more, important.3 The pre-crisis leveraged
search for yield resulted in an unprecedented expansion of debt within and across countries'
financial systems (Chart 10). Much of this "banking glut"4 can be traced to the advanced
economies: for example, around half of the gross inflows into the United States just before
the crisis came from European institutions, rather than emerging economies.5
Now global capital flows of this nature can be valuable. They help to oil the wheels of the
international financial system, allowing saving to flow to where it can be most effectively
used. They allow banks to diversify across national boundaries, reducing their susceptibility
to idiosyncratic domestic shocks. And they increase the degree of competition within the
domestic banking market. But by increasing the linkages between financial systems, they
can also increase systemic vulnerabilities. In this case, banks became dependent on
shortterm funding from overseas, rather than their traditional domestic deposit base. When
investors re-trenched, that funding dried up and banks struggled to find viable alternative
sources of funding. Ensuring gross capital flows are not excessive is just as important as
avoiding excessive net capital flows.
Moving to a sustainable equilibrium requires a narrowing in the international payments
imbalances. And we have indeed seen such a narrowing since the start of the crisis. For
instance, the International Monetary Fund (IMF) expects a current account deficit in the
United States of just under 3% of GDP this year, while the Chinese surplus is expected to
have fallen to around 21⁄2% of GDP. But, as with the euro area, the crucial question is how
much of this narrowing is simply a reflection of the cyclical weakness in the deficit economies
or whether it represents a more durable shift in the pattern of demand in both deficit and
surplus economies. If it is down to the former, then the imbalances can be expected to
reemerge as recovery proceeds.
The answer to this question depends very much on the degree to which the substantial
shortfall, relative to pre-crisis trends, of activity in the deficit economies represents a
permanent impairment of supply potential as a result of the financial crisis and subsequent
Inflation Reports
recession, or whether it will ultimately be reversed. Successive and
speeches by several MPC members6 have addressed this issue in the context of the United
Kingdom, and I think it is fair to say that the evidence is presently inconclusive.
Chart 11 provides an assessment, drawing on IMF analysis, of the evolution of structural
deficits and surpluses for two alternative scenarios, with the red dashed line corresponding to
an assumption that supply impairment in the advanced economies as a result of the crisis is
minimal (and therefore output gaps are correspondingly large), whereas the blue dashed line
- which corresponds to the IMF's central case - assumes a relatively high degree of supply
impairment (and therefore substantially smaller output gaps). In the former case, the bulk of
the post-crisis narrowing in imbalances is attributed to cyclical factors, whereas in the latter
they are attributed to structural factors. Clearly, depending how one reads the data, one can
arrive at a different conclusion.
An alternative way into this is to look at what has happened to relative prices, rather than
quantities. A natural counterpart of a rotation in demand from the advanced to the emerging
world should be a fall in the real exchange rates of the former and a rise in those of the latter.
By increasing the profitability in deficit countries of producing internationally tradable goods
and services relative to that of non-tradables, that should facilitate the necessary shift of
resources between sectors. The opposite is true for the emerging economies. Chart 12
shows such a shift has taken place since before the crisis, with both sterling and the dollar
depreciating in real terms, and the renminbi appreciating. So there is evidence that at least
some of the necessary structural adjustment has taken place, though in all likelihood it still
has further to run.
What sorts of policies would facilitate the required adjustment without relying on sustained
weakness in the indebted countries? At Pittsburgh, in 2009, the G20 identified five
ingredients. First, surplus countries should take steps to boost domestic demand. Second,
deficit countries should implement credible strategies to support private savings and restore
fiscal sustainability. Third, exchange rates need to be allowed to reflect underlying
fundamentals. Fourth, financial regulation and supervision should be strengthened to prevent
the re-emergence of financial sector excesses. Fifth, structural reforms should be pursued,
not only to boost long-term growth but also potentially to boost demand in the short run.
This sounds straightforward, but why has it in practice proved so difficult to achieve? First
and foremost, the actors have not always shared the same diagnosis of the underlying
problems. Second, in circumstances like the present, when there is still a significant margin
of spare capacity in many economies, an expansion in activity in one country generates
beneficial spillovers onto other countries (the opposite would be the case if there was excess
demand and overheating). But policy makers typically do not take account of these spillovers
when judging how much to stimulate their economies. Consequently uncoordinated
decision-making can lead to inefficiently low demand. Moreover, the space for policy action
in the deficit countries is in most cases circumscribed, placing more of the onus on the
surplus countries that have more room for manoeuvre.
Now, in principle, coordination could generate a better outcome by helping policymakers to
internalise the consequences of their actions. And that is indeed what the G20 Framework
for Strong, Sustainable and Balanced Growth set out to achieve. But implementing such a
coordinated outcome turns out not to be so easy. In part that follows from the inherent
asymmetry noted above, namely that the pressure to adjust is always greater on the debtor
than the creditor. In addition, because multiple actions by multiple actors are needed, there is
a genuine difficulty in ensuring that agreements are stuck to and free riding is avoided. And
that is more of a problem, the weaker are the political ties between countries. For these
reasons, examples of successful macroeconomic policy co-ordination are few and far
between and have most often occurred when everyone is pulling in the same direction, such
as at the time of the London G20 Summit in 2009 when policy makers around the globe were
staring into the abyss. After all, as Samuel Pepys remarked: Nothing concentrates the mind
like an imminent hanging.
But I do not wish to conclude by offering too downbeat an assessment of attempts to achieve
a better economic outcome through international policy coordination. At a minimum, the
exchange of views and a better understanding of country positions may help to avoid even
worse outcomes. For example, in 2009, there was real concern that countries might respond
by resorting to protectionist measures. That has, by and large, been avoided.
And some aspects of the international policy process have worked well. A good example is,
in my view, provided by the redrawing of the scope of financial regulation. Here the G20 has
set the overall political direction and tone, delegating the task of developing a detailed
template for new international rules and regulations to the technocrats on the Financial
Stability Board and the Basel Committee on Banking Supervision. This division of labour has
enabled a substantial amount of new regulation relating to matters such as bank capital and
liquidity requirements, financial sector compensation, and the principles for handling failing
financial institutions to be developed in a relatively short period of time.
So, despite the modest progress in restoring our economies to Strong, Sustainable and
Balanced Growth in the global economy, policy makers can claim some successes. And on
that more upbeat note, let me conclude. Thank you!
References
Bean, C R (2002) "The MPC and the UK economy: should we fear the D-words?", Speech
given to The Emmanuel Society.
Borio, C and Disyatat, P (2011) "Global imbalances and the financial crisis: Link or no link?",
Bank for International Settlements Working Paper No 346.
Broadbent, B (2012) "Productivity and the allocation of resources", Speech at the Durham
Business School.
Cecchetti, S G (2011) "Global imbalances: current accounts and financial flows", Remarks
prepared for the Myron Scholes Global Markets Forum, University of Chicago.
Dale, S (2013) "Inflation and growth: what role for monetary policy?", Speech given to the
Asian Business Association and Chinese Business Association of London Chamber of
Commerce and Industry.
King, M A (2000) "Balancing the economic see-saw", Speech.
King, M A (2006), Speech given at a dinner for Kent Business Contacts in conjunction with
the Kent Messenger Group/Kent Business.
Miles, D (2012) "Monetary policy and the damaged economy", Speech given at the Society of
Business Economists Annual Conference, London.
Shin, H S (2012) "Global banking glut and loan risk premium" Mundell-Fleming Lecture,
presented at the 2011 IMF Annual Research Conference.
Tucker, P M W (2012) "National balance sheets and macro policy: lessons from the past",
Speech at the Society of Business Economists" Annual Dinner.
Chart 1: Saving ratios of different groups of households(a)
Per cent
30
25
Low-debt mortgagors (28%)(b)
20
Outright owners (29%) 15
10
Total LCF survey
5
Renters (19%)
0
High-debt mortgagors (25%)(b)
-5
-10
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Sources: Living Costs and Food (LCF) survey and Bank calculations.
(a) Saving ratios calculated using the average consumption and disposable income levels for each group of households. Numbers in parentheses
show their share of total income in 2007. Shares do not sum to 100 due to rounding.
(b) High-debt mortgagors are defined as having outstanding mortgage debt of more than twice their annual disposable income. All other mortgagors
are low debt.
Chart 2: Ratio of UK exports to UK-weighted rest of G7
imports(a)
Indices: 2003 Q1 = 100
140
Goods 130
Services
120
110
100
90
80
70
1994 1997 2000 2003 2006 2009 2012
Sources: Eurostat, Japan Cabinet Office, ONS, Statistics Canada, Thomson Reuters Datastream, US Bureau of Economic Analysis and Bank
calculations.
(a) Chained-volume measures of UK goods (services) exports divided by real imports of goods (services) in Canada, France, Germany, Italy, Japan
and the United States, weighted using UK 2011 goods (services) export shares from the 2012 Pink Book.
UK goods exports data have been
adjusted for MTIC fraud by an amount equal to the ONS goods import adjustment.
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Chart 3: Net international investment positions (% of GDP)
Percentage point changes since 2000
60
Germany Ireland Spain
France Italy Portugal 40
Greece
20
0
-20
-40
-60
-80
-100
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Eurostat.
Chart 4: Pre-crisis euro-area output gaps(a)
Per cent of
potential GDP
7
Revisions between 2007 and 2013
6
Current estimate
5
4
3
2
1
0
France Germany Ireland Italy Portugal Spain
Source: International Monetary Fund World Economic Outlook, April 2007 and April 2013.
(a) Data sourced from April 2007 and April 2013 IMF estimates of the output gap for each country in 2007.
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Chart 5: Spreads of 10-year sovereign bonds over Bunds
Percentage points
7
Euro launch
6
5
Italy
4
Spain
3
2
1
0
-1
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Source: Bloomberg.
Chart 6: Domestic demand and GDP
Indices:2000 = 100
140
Domestic demand GDP
130
Germany Germany
120
Spain Spain
110
100
90
80
70
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
Source: Eurostat.
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Chart 7: Nominal unit labour costs
Indices:2000 = 100
160
Non-tradables Tradables(a)
150
Germany Germany
140
Spain Spain
130
120
110
100
90
80
70
60
2000 2002 2004 2006 2008 2010 2012
Sources: Thomson Reuters Datastream and Bank calculations.
(a) Tradable goods or services are defined as those potentially tradable, rather than actually traded. Tradable sectors are defined as: agriculture,
forestry and fishing; industry; information and communication services; and financial and insurance activities.
Chart 8: Euro-area activity since the pre-crisis peak(a)
Contribution to cumulative
percentage change in GDP
20
10
0
-10
-20
Imports
-30
Exports
Domestic demand -40
GDP
-50
Germany France Italy Spain Portugal Ireland Greece Euro area
Sources: Eurostat and Thomson Reuters Datastream.
(a) Pre-crisis peak is in 2008 Q1 other than for Italy (2007 Q3) and Portugal and Ireland (2007 Q4).
United States United Kingdom
(a)
Vulnerable euro-area countries Germany
Japan China
(b)
Oil exporters Rest of Asia Per cent of world GDP
Rest of the world
3
2
1
0
-1
-2
-3
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Source: International Monetary Fund's World Economic Outlook, April 2013.
(a) Includes Greece, Ireland, Italy, Portugal and Spain.
(b) Includes Nigeria, Norway, Russia, Venezuela and the Middle East and North African region.
Chart 10: Global current account imbalances and gross
capital flows
(a) (b)
Total current account surpluses Total current account deficits (lhs)
BIS bank outflows BIS bank inflows (lhs)
(d)
(c)
Gross capital outflows Gross capital inflows (lhs)
Per cent of
Per cent of world
GDP (inverted) world GDP
20 20
15 15
10 10
5 5
- +
0 0
-+
5 5
10 10
15 15
20 20
1980 1984 1988 1992 1996 2000 2004 2008 2012
Sources: Bank for International Settlements, International Monetary Fund World Economic Outlook and Bank calculations.
(a) Sum of global current account surpluses.
(b) Sum of global current account deficits.
(c) Sum of global net purchases of foreign assets by residents.
(d) Sum of global net purchases of domestic assets by foreigners.
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Other current account deficit countries China and emerging market Asian economies
Germany and Japan Oil exporters
United States Rest of the world
Cyclically adjusted, assuming substantial supply impact Cyclically adjusted, assuming little supply impact
4
Per cent of
world GDP
3
2
1
0
-1
-2
-3
Forecast
-4
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: International Monetary Fund World Economic Outlook, April 2013.
Chart 12: Real effective exchange rates(a)
Indices: January 2007 = 100
140
United Kingdom United States Euro area
130
Japan China
120
110
100
90
80
70
60
2007 2008 2009 2010 2011 2012 2013
Source: Bank for International Settlements.
(a) Deflated using consumer price indices.
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