 Of course, in 2007, the current discomfort broke out with a financial crisis which seemed to originate in U.S. markets, and it's really been the worst experience since the 1930s. It was followed very quickly by the Eurozone crisis, which we can view as a continuation of the 2007-09 crisis. And just to give you a sense of where we have been and where we are now, here are some IMF numbers from the fall of 2011, they're a little bit out of date, on real GDP levels relative to 2006. And as you can see, the industrial countries, which are pretty much down here, are really barely back to where they were in 2006, let alone 2007. Whereas other areas, emerging markets have actually been significantly better. And within those emerging markets, there are also wide disparities of performance. Developing Asia has continued to do well, Central and Eastern Europe, which was hit very, very badly in the 2007-09 crisis. It's certainly been doing better than the industrial world, but relatively poorly compared to other emerging regions. I want to ask four questions today about the experience since 2007. Number one is this really been novel, is this really unusual in the broad sweep of history or even in the sweep of history since 1970 or so, which was the onset of the modern flexible exchange rate era. Our financial crises predictable at all, or did they just come out of the blue? If they are predictable, how can we predict them, think about them, and maybe take preemptive action to prevent them? In this context, is the Euro crisis a very special type of crisis, or does it bear hallmarks that are familiar from other crises? Finally, if we think we have some answers to these questions, what should we do about it to do better in the future than we've done in the last few years? Going in historical perspective, crises are nothing new. A recent book by Carmen Reinhardt and Ken Rogoff called This Time is Different has gotten a lot of press, and maybe many of you have seen it, and it chronicles the sort of empirical regularities around many, many different types of crises over many, many years. Going way back, Edward III's invasion of France in the Hundred Years War was financed by Italian bankers when he ran into trouble, he defaulted, and this set off a financial crisis in the whole Mediterranean where those bankers were active, and this was a truly sovereign, sovereign default. No doubt going back even further, we can find financial crises of various sorts. More recently, we've had many other crises, not so much in Europe since the ERM crisis of 1992, and many of these were actually more severe than one might thought from the outcome because they were near misses. So in the early 1980s, the developing country debt crisis could in principle have taken down many of the major money center banks in the U.S. and in Europe, but through adept management, this was avoided, though the consequences for the indebted countries, particularly in Latin America, were very severe. They suffered a decade of lost growth. The long-term capital market crisis in 1998 was another near miss where only by skillful management was a potential meltdown avoided in markets. This chart tries to give a sense of some numbers. Pierre Olivier Gourenshaw and I in some recent work have tried to count up crises, and we divide them into instances of currency crisis, banking crisis, and default crisis, either external sovereign default or internal debt default by governments. These types of events overlap very often, but the numbers are here. So from 73 to 06, which is before the current crisis, you can see a lot of different types of crisis as we define them. And if we go past 06 to the recent crisis, according to our count, we have a further six external default episodes, and this is through 2010, so I'm not including Greece in this, but there are countries like Ivory Coast and Jamaica, six more external default episodes, nine currency crises, 21 banking crises, mostly in the advanced economies. Up here, up until 06, you have zero defaults for industrial countries, but now we have one, which is Greece, and maybe more on the way. So there are lots of crises, and there's lots of data for economists to work with. And many, many economists, including myself and Pierre Olivier Gurencha, have worked on how to predict crises. As in the board game Clue, there are lots of suspects generally, and one of the big suspects from recent experience is what are called global current account imbalances, a lot of discussion of these. And indeed, the period before the recent onset of crises was one with historically large imbalances in current accounts, defined as discrepancies between national saving and national investment. If you're saving more than you're investing, then you're buying foreign assets, and conversely, you're borrowing abroad if your investment exceeds your saving. Interestingly, this global configuration was mirrored within Europe, as all of you know, with the important difference that, whereas on the global scene, rich countries were running big deficits, within Europe, it was the relatively poorer countries. And also Ireland, which had been relatively poorer, but had caught up to a significant degree that were running the deficits. Globally, here's what the picture looks like, and you can see, starting in the early 2000s, these deficits spread out. The yellow bar is the, you know, I sort of add together the U.S. and the U.K., the sort of Anglo-Saxon, you know, behemoth, very big deficits, mirrored by, of course, surpluses in Asia, in oil producing countries. Even commodity exporters in Africa and Latin America began running surpluses in that period, so very unusual. And these, of course, sharply contract once the crisis starts, reaching a low point in 2009, after the Lehman event. Picture in the Eurozone is probably familiar, but just as a reminder, you know, you have Greece and Red reaching about 15% of GDP deficit on current account, but also Portugal is not far behind. Either Spain, Ireland reached a substantial deficit in 08. And on the other side is Germany running, you know, historically large surpluses. So in Eurozone 2, there are big imbalances. And so one might say, you know, okay, we have these big imbalances, then we had crises, crises are caused by imbalances. My view is that that's a very superficial reading of the data. And in fact, that's kind of shooting the messenger. As I said, the current account is the net flow of international lending. And importantly, it's not something that sort of is inflicted on a country like today's weather. It's the outcome of many, many, many saving and investment decisions by households, by firms, and also by government. And I think it's more productive to view these current account imbalances as symptoms of deeper underlying problems. These are not directly causal, but when you see them, you should actually be concerned. So in the case of the Eurozone, I think policy makers should have looked at these with much more alarm than they did at the time. But the sort of mantra and the ideology of the Euro said, well, within a currency union, the current account can't possibly matter. Look at the United States. What is the current account surplus or deficit of the state of California? We have no idea. There's no way to figure it out. The data aren't there. No one cares about it. Why then in the Eurozone should anyone care about it? Well, the answer is related to issues that I'll bring up later. I'm sure we'll discuss after the talk the structural features of the Eurozone are very different from those of the US currency union. These imbalances, however, the fact that they could get so very, very big, did reflect financial globalization, which has proceeded at a very rapid pace, especially since the early 1990s. Within the Eurozone, a big factor was the single currency, which removed exchange rate risk from the picture. The increasing, though still incomplete integration of financial markets and banking sectors. And in the world at large, much more financial intermediation and two-way flows than we had seen previously. One measure of this increasing financial globalization, is just the scale of gross assets and liabilities in world markets. And much of what we know here has been highlighted by work by Phil Lane and his co-author at the IMF, John Maria Malesi Ferretti, who have sort of systematically constructed, based on a unified methodology, the gross assets and liabilities of basically all the countries in the world. And if you look at these by income group, here's the sort of picture you get. So these numbers, in red is for high income countries, the average of gross foreign assets and liabilities relative to gross domestic product. And when I say average, I mean the GDP weighted average. And this number, just starting in the early 90s, starts taking off exponentially. There's a collapse to some degree in the, you know, after the Lehman crisis, but it's bouncing back. And the numbers are huge. You know, on average, they're over twice GDP now. For emerging markets, there has also been a process of increasing financial globalization, but it's nowhere near as extreme as in the case of the advanced economies, the AEs. These averages conceal sharp differences among individual countries. So, you know, the U.S. is a sort of large, relatively closed in some senses. And those numbers would be lower for the U.S. but for small economies, especially those that are hosts of significant foreign financial activity, the numbers are really huge. So, here's the example of Ireland. Assets held abroad and external liabilities compared to GDP are, you know, above 15 times higher. Now, much of this represents financial institutions that have a physical presence here but really have little to do directly with the Irish economy. But still, you know, there's a lot there. And, you know, the net numbers are nowhere near as large. They, you know, actually are not that bad until a recent last couple of years where they've plummeted to, you know, basically the net foreign asset position is about equal to minus GDP now. And Phil Lane has discussed some of this in a recent paper. I don't think it's completely well understood why this has happened. Okay, so we've had a lot of financial globalization, big current account imbalances, and big crises. What do the statistics tell us? Well, if you look at a very large body of work by economists using econometric methods, it turns out that it's not really a robust fact that if you have a bigger current account deficit, the probability of a crisis goes up. That's actually not something you can definitively establish. Different studies have different findings. But it seems that in and of itself a big current account deficit is not going to tell you definitively that crisis probability is higher. Though I still believe that it's something that one should be concerned about. It should cause one to ask why is the current account deficit so big and is this actually sustainable? But there are two factors, three factors actually that do seem to be very robustly important. A real appreciation of the currency. So basically when your price level rises more quickly than the price levels of other countries measured in the same currency so that you lose competitiveness, so that your cost of living rises relative to the rest of the world, that seems to be a significant risk factor. And the other significant risk factor is the growth of domestic credit. You have a big lending boom. That seems to be a problem more often than not. And domestic credit growth is related to current account deficits. The U.S. used domestic credit growth before the crisis also a big deficit. So if you see a current account deficit and domestic credit growth, then be afraid. For emerging markets, international reserve levels tend to be important predictors of crises. Though again, this is one of these facts that's a little hard to interpret because typically before crises countries lose reserves. So the international reserve level may be predicting crises not because it's telling you about government policy but because it's a very direct reflection of what the market expects. But for everyone, real appreciation, domestic credit growth seem to be robust. So one might take those findings and say, okay, let's look at the euro crisis. How different was the euro crisis? And does it fit this mold? And the answer is that it really works damn well if you look at the euro zone countries that are having problems now. Now Tolstoy famously wrote that every happy family is the same. Happy families are all alike. Unhappy families are all unhappy in their own ways. And so crisis countries all have specific features that make things better or worse and that may make them miserable in very special ways. The euro zone certainly has these features. And we can talk about some of those. But just looking at these sort of canonical indicators, real exchange rates and domestic credit growth, the evidence is clearly there. So here are measures of real exchange rates for Germany where you see, so basically if you move up, your currency appreciates in real terms. We know what's happened in Ireland both before the crisis and then in the very harsh correction, a lot of deflation, so a lot of real depreciation in recent years. We see for the other crisis countries, Spain, Portugal, Greece, significant real appreciation since joining the euro. Italy shows some too though I don't have them on this graph, not as extreme. Real appreciation feeds through to the economy in various ways. It makes you less competitive but also the participation of higher inflation leads to lower real rates of interest given that if you're in a single currency, you basically have the same nominal rates apart from the expectations of default risk which were absent in the euro zone until recently. And this lowering of real interest rates can lead to very perverse dynamics and I think it did in the case of the euro zone. So this is something that was actually predicted by Sir Alan Walters years ago when he was advising Margaret Thatcher about the advisability of Britain's entry into the euro zone. But you have this convergence in nominal interest rates when you have a currency union, countries that are growing quickly and that have higher inflation rates, countries like Ireland for example, will have lower real interest rates. These will increase expenditure. They'll lead to a bigger current account deficit. They will cause even more inflation because of the expenditure increases. And so there's a kind of unstable dynamic there which I think well describes what happened in the early years of the euro zone. And just to give you a sort of picture of real interest rates, here's what happened. So these are the real interest rates relative to Germany of the countries that are now finding themselves in the most difficulty with regard to sovereign debt. And you can see that these all dropped below zero and they actually dropped starting in the late 90s because even the anticipation that the Maastricht Treaty would come into effect led to convergence in yields in the euro zone. And it's only more recently that rates have come up to zero with the most above zero, with the most sort of shocking case being that of Ireland. These are ex post real interest rates which means I subtracted actual inflation but for Ireland the extreme deflation has led to very, very high real interest rates indeed. Domestic credit I mentioned is another indicator of future crises. And again you can see for the crisis countries where I include Spain as a crisis country a lot of domestic credit growth. Starting really to accelerate in the early 2000s at least for Spain and Ireland where there were building booms not so extreme at that point for Portugal but still significant. And then Greece has the same although Greece has just generally a lower level of financial development measured by ratio of domestic credit to GDP than these other countries. But still there too you can see this. Okay so the European story is very familiar and there's a whole list of special features about the euro zone that we can talk about later if we wish. Of course you can't devalue your currency unless you leave the euro, which one does not want to do lightly. But there's no fiscal union backing up this rigidity of the currency. Credit has been extended within the euro zone inter-European official credits to crisis countries but they've come with a degree of conditionality on fiscal policy which to my mind has been rather excessive and perhaps counterproductive. The Maastricht Treaty restricts the ECB in terms of what it can comfortably do. It restricts bailouts of various kinds. And the structure of European financial markets leads to banks having an excessive exposure to local sovereign debt. One of the issues here is the absence of a European bond that can be used in monetary policy operations. So what do we do? What do we conclude from these empirical data from these regularities if we want to avoid future crises? We don't have time to go into these now but it's a good fodder for discussion later. In the euro zone a common bond is actually a major issue I think in stability going forward and in the conduct of monetary policy. A group of European economists which includes Philip Lane have recommended a way in which such a common bond can be constructed without actually any need for a change in the treaty or any violation of the treaty just through financial engineering. There are things one could do along these lines that would be very helpful but they're not getting talked about enough. The regulatory framework that has been in effect until the crisis basically leaving things at the national level is something that hasn't worked and that can't possibly work and so some sort of shared regulatory framework beyond what has been done beyond the European banking authority needs to be constructed. Bigger firewalls and going with those and enhanced fiscal union. The resolution framework is very important by which I mean what do you do when banks especially cross-border banks fail? How do you wind them down? How do you wind down sovereigns such as Greece in an orderly manner? The Greek deal was done by the seat of the pants and caused massive disruption in financial markets and sovereign debt markets and structural growth promoting reforms about which there's been a lot of talk but much less action are certainly needed and maybe the crisis will help bring some of those about and if so that would be a good outcome. Solving the Eurozone problem of course still leaves the world economy which itself had a major crisis from which we may not be fully saved and if I look at what's needed in the world economy I come out with a list that actually looks just like the list I gave you. Think about a common global bond that might not be such a bad thing as a reserve vehicle or if not that some sort of credit lines in multiple currencies because what we learned in the crisis is that the traditional lender of last resort model where say the Fed lends to US banks the ECB lends to European banks is not adequate anymore in a world of financial globalization. Financial regulatory framework you can't do it on a nation by nation basis when all the financial markets are so closely interconnected. More firewalls, more resources for the IMF and that goes with implicitly at least enhanced fiscal union because those resources come from taxpayers in the various countries. The international resolution framework is in as sorry a state as the European one and the one mitigating factor on the global scene is that countries can devalue and that can be helpful but structural reforms in many countries outside the Eurozone would certainly help in the current situation. To conclude we can ask why these lists are actually so similar why are the challenges so similar inside and outside the Eurozone and it's simply because many of the problems are due to financial globalization which extends way beyond the Eurozone and cause the same sorts of issues to arise globally. One can imagine a sharp worsening of the Euro crisis having big impacts on financial markets outside the Eurozone simply because of all of the interconnections between the financial players. Solution to all of these problems is going to be hard to achieve and if it's so hard to achieve in the Eurozone imagine how hard it is to achieve more globally but nonetheless I think that's the challenge we face. We've constructed over the past couple of decades a world that is more globalized than ever before than in any other epoch in history in terms of trade and especially financial markets and the question I want to leave you with is whether the perimeters of globalization can safely exceed those of governance. There's a debate in any currency union in the Eurozone in the United States about what gets left at the local level what doesn't. The U.S. Constitution recognizes that anything involving interstate commerce whatever that is can be legitimately the domain of the federal government and in the U.S. there's a big debate over whether healthcare reform is interstate commerce or not. Obviously in the U.S. this is a big issue in the Eurozone what gets left at the national level is a big issue. In a world of globalization markets much more needs to be solved at the global level whether it be the Eurozone or the world economy as a whole and how you do that is obviously a major political challenge. Stop there.