International Financial Multiplier

Japjeev Singh Anand Varun Gandhi Ankur Sikri Apoorv Prakash Singh Gaurav Phadke

Propagation of a crisis
There are several ways a crisis can spread from

one country to another. This domino effect propagates via several routes Trade, information, common creditors, leverage, debt defaults, carry trades, speculative attacks and stimulus withdrawals are some of the channels for spreading of financial contagion Today we will be focusing on a paper written by Paul Krugman in the wake of the Sub-prime crisis in October 2008 International Financial Multiplier

The great Depression US: Lower trade => lower GDP

World Trade

Initial work
Trade Multiplier:

Country As GDP affects its imports, which are country Bs exports, thus transmitting demand shocks

International Trade Multiplier

Not Just Trade Multiplier !

Initially, it was believed that trade linkages

between world economies spreads financial contagion; this has not been true post the Great Depression The East-Asian crisis and Russian currency crisis showed that there were other channels of contagion amongst countries

A crisis with No Trade Linkages

The Idea
Changes in asset prices are transmitted

internationally through their effects on balance sheets of highly leveraged financial institutions Crisis propagates through the balance sheets of banks

As usual, the Sub-prime crisis

180 160 140

120 DJIA 100 S&P 500 NASDAQ 80 Hang Seng Singapore 60 BSE FTSE 100 Greece 40

20

Propagation of the Crisis

Assets Supply Shock

Causes supply shock and falling asset prices there

High Supply

Reduces asset buying in other country

Falling asset value

Decrease in capital

Balance Sheet contraction

The International Finance Multiplier in Business Cycle Fluctuations Naohisa Hirakata and Takushi Kurozumi

 Modeling Supply Shock in a single country system

Modeling Supply Shock in a two country system

Home Price Index (HPI) U.S.A.

Decline in asset prices hits banks

Balance Sheet Contraction
60 50

40

30

20

10

Balance Sheet Contraction (in $bn)

Implications
Core problem is capital, not liquidity

Financial coordination is as important as macro-

economics in policy making

Balance Sheet Effects: Credit and Liquidity Shocks

Pre Shock Balance Sheet

Credit quality shock triggers shocks to funding and capital

Post-shock balance sheet

International Interbank Borrowing, December 2005September 2011

Kalin Tintchev. IMF Working Paper. WP/13/14. Connected to Whom? International Interbank Borrowing During the Global Crisis.