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Transcript
How Can Spain and the U.S. Recover from
their Depressions
Edward C. Prescott
U.S. Long-Run Picture
 Relatively steady growth over the last 150 years
 Some fluctuations about trend (HP filtered)
Source of following pictures is Robert E. Lucas, Jr.
2
3
Deviations From Trend
 Relative to trend, GDP lost 40% between 1929 and 1933
 Recently the loss has been about 8%, and this has
occurred over the last 14 months
4
5
Stock of Intangible Capital is Huge
 It is as big as the stock of tangible capital
– Tangible capital is about 3.8 times GDP, which is
measured output
– This is $190,000 for every man, woman, and child
 Tangible capital includes
– Houses, factories, vehicles, roads, office buildings,
retail stores, some software, computers, etc
Reason for Depression Was Not the Financial
Crisis
 Except through policies it led U.S. to adopt
 Depressed U.S. economy depressed rest of world
 China, India, and Brazil have already resumed healthy
growth
 Europe, with exception of some Mediterranean
countries, will soon
What Are the Roles of Financial System?
 Saving for retirement
 Financing capital
– In the US of the 3.4 GDPs of private capital
• half equity (owner) financed
• half financed by debt
• this is the case for real estate, which is the biggest
component of capital
Total Household Borrowing Equals Total
Household Lending
 Lenders are people saving for retirement
 Borrowers are people who own businesses with debt
– This debt is the debt of the owners
– Household businesses have big debt
– Unincorporated businesses have big debt
– Corporate businesses have big debt
Parallels Between Current and the Great
Depression
 Both started with collapse of a real estate boom
 Both started with the near complete cut off of
immigration
 Both times, stimulus plans were instituted with large
increases in spending and taxes
 Both times, there was a shift to anti-trade policies
 Both times, the White House started managing the
economy
The Reason that the US Economy had a Great
Depression in the 1930s and is Currently Depressed is
NOT the Financial Crisis
 No financial crisis until U.S. was well into the Great
Depression
 And then it was a small crisis
 Businesses had funds to make profitable investments
 Businesses had huge cash flows
 They paid big dividends rather than financing
investments with retained earnings
 This implies a lack of perceived profitable investments
Reason for Not so Great Current Depression
is the Same
 Businesses have funds or access to borrowing to make
profitable investments
 Currently U.S. banks are lending huge amounts to the
Federal Reserve Banks
 This lending is at a low rate
– 0.25% nominal
– negative real
 Problem: Banks do not have good lending opportunities
Current US Depression
 Politicians are trying to foster more construction even
though there is an excess supply of houses.
 One way to stimulate the depressed construction
industry is to destroy half the housing stock
– If done, there would be a construction boom
– This would be bad policy
U.S. Should Ban Institutions that Borrow from
One Group and Lend to Another and
are Highly Leveraged
 Such as Long Term Capital Management, Bear Stern, Lehman
Brothers
 Mutual lending organizations are good
– People lend and bear the risk of bad loans
– Institutions like Caja Navarra should be encouraged
– Mutual pension funds should be encouraged
– Mutual bond funds should be encouraged
 Reserve requirements for commercial banking should be high and
government insured deposits minimal
What Depressed the Economy today and in the
1930s?
 Not market failure
 Rather failure of the central government
 If people expect higher tax rates on distributions from
their businesses in the future, they rationally
– cut investments now and
– increase current distributions
What Will Make the Economy Boom
 Cut marginal tax rates
– People will work more
– Businesses will invest more
– Output and personal consumption will increase
 Be open
 Do not erect barriers to the use of better production
processes
Another Way:
Pray for Another Technology Boom
 The economy will boom if there are abnormally large
increase in the technology level as happened in the first
half of the 1960s and last half of the 1990s
– Politicians should not pander to special interest
groups with vested interest in currently use inferior
technologies of production
– If they do, there will be no boom as barriers to using
the new superior technologies will be erected
Cutting Government Expenditures Will Help
 The increased expenditures in World War II increased
employment and output
 But it reduced welfare as household consumption and
leisure fell – just as theory predicts
 Governments should make investments only if the
benefits exceed the costs
– If benefits exceed costs, they stimulate the economy
– If not, they depress the economy
Increasing Marginal Tax Rates will Not Increase
tax Revenue
GDP and Tax Revenue per Person
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
GDP
Tax Revenue
0
0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9
Tax Rate, t
1
20
Welfare
 Because of taxes, the value of time on margin
used in market sector is twice that used in
nonmarket sector (If tax rate 50%)
 Nonmarket time is valuable
 Welfare gains in lifetime consumption
equivalents per year are …
21
Welfare Gains and Losses
10%
Current U.S.
0%
-10%
Europe
-20%
0
0.1
0.2
0.3
0.4
0.5
0.6
Tax Rate
22
Macro Theory Works
 Given productivity, population, and taxes:
– Predicted and actual paths of the aggregate variables
coincide
– All using dynamic economic theory to construct
models consistent with national account and other
data find same thing
– All find monetary policy has and had little real
consequence
23
Then What Depressed the U.S. Economy
 Fact: Investment suddenly became depressed in the last
third of 2008 – there was a regime change
 There are 25 million small businesses in the U.S. and 5
million of them have employees
 Their owners feared higher tax rates with the regime
change and they
– Rationally cut investment
– Rationally cut employment
– Took more cash out of business
 Workers fearing job loss rationally cut auto buying
24
Fears Are Being Realized
 Tax rates are being increased
 These increases lower amount of capital a firm chooses
to have
 Reason for low investment is not problem of getting
loans – it is expected future high tax rates
25
Liabilities of Households and of
Nonfinancial Businesses They Own
End 2007
End 2008
31,875
32,341
Mortgages
44.9%
44.4%
Other Loans
18.0%
18.5%
Corporate Bonds
11.2%
12.0%
Security credit
1.0%
0.5%
Trade payable
8.2%
8.5%
16.8%
16.1%
Total Liabilities
(billions $)
Composition Share
Other
26
Cost of Current Crisis
 Huge bailout of lenders to financial intermediaries by
taxpayers
 This means higher tax rates in future and a depressed
economy now
 The ‘stimulus’ plan is a depressant plan
 To argue spending stimulates the economy is equivalent
to arguing cigarettes are good for your health or CO2 is
not a greenhouse gas
27
Evidence that Low Marginal Tax Rates Boost
an Economy
 This uses the simple methodology developed in my
American Economic Association 2002 Ely Lecture
 Factors other than the marginal tax rate matter, so fit not
perfect
 Also errors in measuring hours worked
28
Predicted vs. Actual Weekly Hours
predicted
30.0
Japan
Australia
28.0
New Zeland
26.0
Ireland
Portugal
Spain
24.0
Romania
U.S.
U.K.
Canada
22.0
20.0
Iceland
France Germany Denmark
Italy
18.0
16.0
16.0
18.0
20.0
22.0
actual
24.0
26.0
28.0
30.0
29
Effective Measures Against the
Depression in U.S. Economy
Cut marginal tax rates
 Become more open
 Follow pro-productivity policies
 Reform labor market policies so workers move quickly
from where they are less productive to where they are
more productive
30