Tim Phillips  00:01

Hello, it’s Tim here. A couple of weeks ago, I was at the Paris School of Economics for the PSE-CEPR Policy Forum 2026. We’ve got loads of episodes to bring you in the next few weeks that were recorded at the event, but we’ve been focusing on global imbalances a lot recently, and so we wanted to bring you this episode that we recorded at the forum on that topic as soon as possible.

Gita Gopinath  00:33

At least there are several areas in which it’s clear that progress needs to be made. What I worry about is the lack of political will.

Tim Phillips  00:42

In her keynote, Gita Gopinath of Harvard University described the third wave of global imbalances. Wave one led to the Plaza Accord. Wave two to the Global Financial Crisis, which — if you were lucky enough to miss it — you really don’t want to have back again. We know how banks fail, so even if the second wave did end badly, we have a map for that. Well, this time with huge amounts of government debt, non-bank finance, and equities held by foreign investors and non-bank institutions, how does this all unwind? Gita is here with me now, also Philip Lane of the ECB and CEPR, to discuss what central banks can and can’t do about it. Welcome to VoxTalks Economics, both of you. Hello, Gita.

Gita Gopinath  01:31

Hi, Tim.

Tim Phillips  01:32

And hello, Philip.

Philip Lane  01:33

Great to be here.

Tim Phillips  01:47

Gita, first of all, what is causing a wave of imbalances? What is common to all three of these waves?

Gita Gopinath  01:54

What is common to all of the waves is what we think as some of the primary drivers of global imbalances, and just from a pure accounting perspective, global imbalance is about the difference between national savings and national investment. And so, there are times in history when you have some countries that are running big deficits — which is that their national investment is far enough in excess of their national savings — and on the flip side, you have other countries who are running big surpluses. Now across the three waves, what has been common is that the US has been the deficit country in that equation — both before the Plaza Accord, before the Great Financial Crisis, and now. On the surplus side, of course, the countries have changed somewhat. Before the Plaza Accord, it was Japan. Before the Great Financial Crisis, it was basically China and East Asian economies. And now it is China again. So there are some differences, but yes, in terms of which is a country that’s always been on the deficit side, it has been the US,

Tim Phillips  03:07

And in 2007, going back to the last time round, then the world savings were in American mortgages. Where are they now?

Gita Gopinath  03:16

So, the good news this time around is if you look at household balance sheets and bank balance sheets, they are in much better shape than they were just before the Great Financial Crisis. So, I think we should take some comfort from that: that, at least compared to back then, if there were going to be a crisis, at least it doesn’t seem like it would be — may not be — as persistent and as damaging as it was after the Great Financial Crisis. So, what is different now is the fact that the fragility has rotated away from households and banks towards governments, that have now much higher levels of debt to GDP, and non-bank financial institutions, that are [a] very big part of the financial landscape, and that we have only limited visibility into their exposures to different asset classes and their connection with the banking system. So, I think those are the unknowns in terms of what may play out.

Tim Phillips  04:16

And foreign holdings of US equities. What is it, about 40 trillion? Is that right? Does that concentration matter for how this wave could break?

Gita Gopinath  04:26

So, that’s what’s very different about this time, which is the huge appetite for US equities from all parts of the world, for two reasons: one, because of the big AI boom in the US, and the multiple assets that can be traded, and to be a part of that AI boom, and also because of the fact that there is just — in a sense — no other game in town, which is that the US is in the lead on AI. You have China, which is another big player, but there’s not enough assets associated with China’s trade that you can actually put your money in. And there’s not that much growth and investment and productivity growth happening in many other parts of the world. So, it’s very lopsided in terms of where the rest of the world is saving in terms of equity, and that tends to be in US markets. And so, if there were a correction, I think this time around we would see — obviously, the effect on US consumers and US investment and US GDP — but also, the spillovers to the rest of the world, given the very large exposure of the rest of the world to US equities.

Tim Phillips  05:38

Philip, from where you sit, what makes this wave different?

Philip Lane  05:41

I think it was nice framing, actually, to have this three waves, because it highlights some of the similarities, but also the differences across these episodes. So, let me add to the framing of this third wave — which is over the last decade or 15 years — you’ve had the rise of very large corporations. A lot of these being American-owned, American headquartered corporations. It’s partly to fund the US economy, but partly to fund the global activities of these global firms, including in Europe. So, let me emphasize, when we think about the full interaction here, that a lot of the activity in Europe now — in some key sectors — is driven by the affiliates of American firms, especially in my home country of Ireland. And understanding what’s underneath the global imbalances also includes a lot of intra firm transactions. So, a firm exploiting its technological lead by rolling out its technology — its IP — in different markets, including in Europe. So, I would say again — maybe compared to the last wave — if it were a re-evaluation of the value of these American firms, it’s partly a pure valuation effect. European investment funds who hold shares in those, they would be a hit, but we also know the wealth effect of a falling stock market. It’s there, but it’s mostly long-only funds, and so on. But there would also be the ramifications for the activities of those firms. So, when I think about those scenarios of what happens if there’s a re-evaluation of the AI boom or related issues. Partly, you can do the financial calculations, the valuation effects. Partly, okay, what will be their new strategy in terms of their European activity? So, it’s the whole web underneath, which, you know, I think it’s important to look at.

Tim Phillips  07:05

Gita, do you agree about what Philip’s saying about the risk profile this time around?

Gita Gopinath  07:43

Yes, certainly. I think that is a great point. Also, in terms of even determining whether an imbalance is excessive or not. Knowing the details in terms of the location of multinational activity in different parts of the world, and where they book their profits for multiple reasons, is another very important ingredient of then ultimately determining whether this imbalance is going to be here to stay, and how, and should it be addressed. So, I mean, I think Philip makes a great point.

Intermission  08:19

We will be bringing you more episodes from the Paris Forum in coming weeks. So, if you want to hear from Pol Antràs and Beata Javorcik on what Europe can do when it is caught in the middle of a trade war, Olivier Blanchard on Europe in 2050, or Eric Monnet on the century-old documents he discovered in the archives of the Banque de France, and what they reveal about central bank independence, follow VoxTalk Economics wherever you get your podcasts.

Tim Phillips  08:53

So, one thing we’re also thinking a lot about at the moment is the behaviour of bond markets. What do we not know about the behaviour of a stressed bond market in this kind of situation?

Philip Lane  09:07

Obviously, we think a lot about the bond market. But before jumping to that kind of hypothetical of a stressed bond market, let me emphasize — and again, the answer is different around the world — but, compared to what the European system endured 15 years ago when there was a lot of stress in the European bond market, the European bond market now is a lot smoother for different reasons. One is even though, of course, as Gita said earlier on, public debt has gone up, the underlying macro stability of Europe has improved. In particular, with much healthier banks, and again, that’s just not random. It’s as a result of a lot of policy, a lot of push to improve the capital ratios and liquidity ratios of the banking system. One basic type of fiscal risk has gone down, which is the risk that the financial system will go into stress and then spill over to the sovereign. But part of that is there is more leverage in the sovereign system now. So, I think behind your question, Tim, is essentially, everywhere we observe this rise in public debt races. So, the aggregate public debt ratio of the area countries has gone up. Now it hasn’t gone up as much as in the US or in China, but it’s asking questions there. Let me focus on the European situation. The European bond market has adjusted to the fact that we’re away from low for long. So, before the pandemic, everyone was convinced, for as far as the eye could see, that our policy rate, but also the 10-year rate in Europe, would remain pretty low.

Tim Phillips  10:42

Remember those days.

Philip Lane  10:43

Yeah, and then very rapidly changed in 2022. But since then, it’s been relatively stable, and I think in part is — even though people complain a lot about the European fiscal framework — there is a transnational, pan-European, fiscal anchor. A lot of interrogation of governments about, please tell us how your plan is sustainable. And also in the pandemic, of course, remember there’s a big movement in response to the pandemic risk to share that risk, since some other parts of the world it all loaded onto the national sovereign, in Europe, the most effective countries receive grants. So, there’s different ways to have a rise in public debt. When you essentially try to minimize the risk attached to that rise in public debt, some of those elements have been managed better than might be expected in the European context. So, for now, Europe has a stable bond market. But I think the wider conversation globally about what are the risks attached to rising public debt — and maybe coming back to what Gita said earlier on — also the fact a lot of it is funded by non-bank financial institutions, which we don’t know so much about.

Tim Phillips  11:59

Gita, what is the wider conversation globally about this?

Gita Gopinath  12:02

I think we have to remind ourselves where the world is. Like, if you look at the US in terms of US debt to GDP, just the federal debt to GDP is 100% now. Before the Great Financial Crisis, it was 40% of GDP. So, this is just a remarkable increase in debt to GDP in the US. And in many other countries of the world, the rise has been somewhat less remarkable, but still, what you just have had is a steady increase in public debt. So, the thing — the things — that are unknown and could be new this time around, first, that whoever is, in a sense the marginal price in the sovereign debt markets has also changed. So, in the US hedge funds are now playing a bigger role in terms of market making. And we did see the Dash for Cash episode in 2020, when you had a big increase in treasury rates, at a time when you should have expected — because of flight to safety — the opposite would happen. So, market functioning can break down very quickly. And why is that an issue? Because, besides the fact that that can be very disruptive and generate panic — because you don’t want the safe asset behaving in a volatile fashion — there is also the very big question about how should a central bank react to it. And so, I think from a central banker’s perspective it is probably very good to now create your little playbook about how are you going to deal with these kinds of spikes in yields in public debt markets. Obviously, you don’t want to be there trying to support unsustainable debt levels. You want to be there to address market dysfunction and market distortions, but that requires being very clear about when you’re in, when you’re out. Making a clear separation between monetary policy versus what is about market functioning. And I think that that did not get sorted out very clearly in the US. I would say, even after 2020, there was a lot of bond buying that continued well past the market functioning episode. So, I think that’s one very important area to keep in mind. And, and, you know, the broader question is more generally, is that when the safe asset is behaving in a volatile manner — and obviously the spillover was to the rest of the world in terms of borrowing costs — can be much more severe in terms of the increase in premium that these other governments have to pay in other parts of the world. So, this is the unknown that I think it’s important to maybe build a scenario around as a policymaker and see how would you react if you had a lot of disruption.

Tim Phillips  14:41

Yes, Philip, there is a jumpiness in the markets. We are seeing these events. Gita says that central banks should be building their playbook. Do you see that happening?

Philip Lane  14:51

From our point of view, let me emphasise two or three elements. So, number one, going back to March 2020, we did invent a new programme called the PEPP. The Pandemic Emergency Purchase Programme. Now we like to be very ex ante specific about the purpose when we do something. So, when we wrote the initial legal foundation for that, we said it was a dual-purpose programme. It had a market stabilisation role, but we also had from day zero a stance role. Now, we’re different because we were coming from a below target inflation episode. But it was important, and maybe because our legal system requires us to explain what we’re doing, it was important to be articulate about that. And it made a difference because for the market stability reasons we had to make it a flexible, agile programme. Because historically, when we would do QE, it would be fixed ratios for every government in line with the size of the economy, whereas with PEPP, we said we will vary the ratios across countries depending on where the stress is. Now move on from that, and last year, when we updated our monetary policy strategy, we did formally make this differentiation between asset purchasing for stance reasons — so traditional QE versus asset purchasing for transmission reasons, market stability reasons — and that I think is very important distinction. And then let me mention, of course, twice we’ve had to develop programmes to clarify how we react in different circumstances. So, famously, back in 2012 the OMT was introduced, which was designed to go hand in hand with an ESM programme, where a government has got all the way where it needs to go to official funding. And it gets official funding from ESM, and for the kind of liquidity needs, the OMT will be there. Now that doesn’t cover every risk scenario. So, in 2022 when we started hiking, we also designed another risk programme called the Transmission Protection Instrument, which essentially says we know panics, — unwarranted instability — in markets can happen. And under very specific conditions we can play a role in that. And the ideal is, before you get to any stress, these play a calming role. They play a calming role because investors can game out ‘what do I need to worry about and what can I get some reassurance from’. One pathway in the game you’re playing is taken care of by TPI. But let me emphasise, coming back to what I said at the beginning, that the European fiscal framework is important. We really mean it when we say this is in relation to unwarranted instability, because, of course, there’s always a risk if you make an ex ante commitment, there’s a moral hazard issue. So, we say you have to basically be compliant with the European fiscal framework. You have to be clearly sustainable. But you know, in macro, there’s this grey area. But of course, a super strong sovereign won’t be attacked, and if it’s super weak, it’s its own end game. But that grey area in between, there is some room for this idea that an unwarranted panic can happen, which can be ex ante reduced in likelihood by the TPI. So, we’ve done a fair amount, but probably with a structural change in the world, including the rise of non-bank financial institutions, the fundamentals are remaining in terms of making sure central banks understand its role in liquidity without trying to step in in relation to solvency.

Tim Phillips  15:37

I see, so fundamental to you to not just say what you would do to calm markets, but what you would not do?

Philip Lane  18:33

Exactly.

Tim Phillips  18:34

Gita, politically, should politicians be giving attention to the signals that we’re getting from the bottom markets at the moment.

Gita Gopinath  18:42

Well, I think they should, in the sense that it is a statement about the ability to maintain the kind of spending you want to maintain, without having the revenues for it. There is that there is a gap there, and for which there is not an infinite supply of savings, to be able to close that gap without any increase in borrowing costs. And so, the problem is not just the debt to GDP levels are high, but if you project out, it is increasing over time at global average, for sure. And that is a reflection also because of aging population and what’s required in terms of pensions was required in terms of health care. I mean that all adds up, but in addition, you have all the investments that need to be made for strategic reasons in defence, digital infrastructure, but also for dealing with the climate transition. There are multiple sources of demand in terms of government spending that’s coming up, and therefore I think it’s critically important for governments to pay attention to the space they have. To recognize that, if they are going to have to incur higher levels of defence spending on a permanent basis, that cannot be financed through borrowing, but has to be financed through higher sources of revenue or through cutting spending on something else on a permanent basis.

Tim Phillips  20:14

Okay, I want you to imagine for me that some crisis does actually happen. It might be next year, might be in three years’ time, might be in five years’ time. Hopefully, it’s not next week. And it’s caused by this wave of imbalances. Is there something that we would say afterwards? You know, we really should have done something about that in 2026. We really should have fixed that problem now. Gita, what’s that likely to be?

Gita Gopinath  20:42

I think we are already talking about some of the most important things, which is the role of non-bank financial institutions in financial markets, and the fact that we really need to get greater visibility into how a disruption in financial markets could be amplified through NBFIs. On the fiscal front, we are talking about the importance of governments running smaller fiscal deficits. Especially when, if you look at the US, the deficit is close to 7% of GDP at a time when the economy is in a strong position. So, at least there are several areas in which it’s clear that progress needs to be made. What I worry about is the lack of political will in either of those cases to address them. Which means that typically it takes a crisis to get the political will to actually do what needs to be done, and we may find ourselves in that situation, and then action will happen. But I think there is a lot of sufficient signalling and pointing to what are the areas of fragility for the world. Again, I’m not convinced that the political will exist, including on global imbalances. I think we have now a good consensus on what it will take in terms of US running less smaller fiscal deficits, China relying more on consumption-oriented growth, Europe having more productive investment. This is all very clear, but whether those adjustments will happen at the speed at which they need to happen, I think there were big question marks around that.

Philip Lane  22:22

So, on top of the issue that Gita raised, at this point in time there is a debate around the world about should be some rollback of the improvements in bank capital, bank liquidity, in the regulatory environment.

Tim Phillips  22:36

Absolutely.

Philip Lane  22:37

And this can always be discussions about re-optimising, recalibrating, simplifying, but fundamentally I think — I mean Gita listed a lot — but in general, look around, there’s a lot of risk out there. And the idea in a more risky world that you want to encourage banks or financial institutions more generally to do more risk taking, I mean, there’s a balancing act. We want the European economy to grow more quickly. So, we do want more risk capital, we want savings, investing in Draghi report. So, we do want the Europe to grow more quickly, and that does mean some amount of risk taking in the financial system, but let’s do that in environment which keeps the macro contingencies safe. And then the other point I would say, even though I’ve said it, we all say it all the time, forever. Data gaps, and this is a big coordination issue. We all have glimpses from our different perspective, but it’d be so much value to getting at these non-bank financing sessions, to file more interesting reports that can be shared at some way, confidentially, among the major global systems.

Tim Phillips  23:45

There is a lot of risk around. Philip, thank you very much for talking about it.

Philip Lane  23:49

You’re welcome.

Tim Phillips  23:50

And Gita as well.

Gita Gopinath  23:51

Likewise, thank you. It was a pleasure.

Tim Phillips  24:01

If you want to read the G7 Economist’s memo on Global Imbalances, authors Chong-En Bai, Gita Gopinath, Hélène Ray, and Axel Weber, we will put a link to that in the show notes.

Outro  24:17

VoxTalks Economics is a Talk Normal production. The assistant producer is Megan Bieber, and our editor is Andrei Zagarion.