Download The Great Recession of 2008-09 - University of Wisconsin

THE GREAT RECESSION OF 2008-09:
STARTING TO BUILD THE HISTORICAL PERSPECTIVE
29 April 2009
Wayne Carroll
Department of Economics
University of Wisconsin-Eau Claire
[email protected]
Why is this recession special?
 Maybe the deepest since the Great Depression.
 The government response to this one has been
extraordinary and will have a lasting, historic
impact. The fact that the government has done
this tells us something; but what?
Two possibilities:
 They know something we don’t, and they’re scared. So
we should be scared.
 Maybe it’s a fairly ordinary recession, but they’ve
decided to try new remedies. If so, then this marks a
new era for macro policy.
How do we measure recessions?








Real GDP
Total employment
Unemployment rate
Bank credit
Industrial production
Home sales and prices
Stock market prices and other asset prices
Others
A problem: we don’t have complete, detailed data from
the Great Depression for comparison.
History’s lessons
 The Great Depression
 U.S. recessions:
 2001: following the bursting of the dot.com bubble
 1990-91: perhaps a consequence of the S & L crisis of the
late 1980s
 1981-82: caused by the Fed’s anti-inflation policies
 1974-75: following a sharp spike in OPEC oil prices
 The big five: Spain 1977, Norway 1987, Finland, 1991,
Sweden, 1991, and Japan, 1992
(http://www.economics.harvard.edu/faculty/rogoff/files/Aftermath.pdf)
How did we get here?
 Broad expansion in mortgage lending and
increases in home prices in the 1990s, caused by:
 Low interest rates from 2001 to 2004
 Relaxed lending rules and securitization of mortgages
 Increases in interest rates starting in 2004 and
slower growth or declines in home prices starting
in 2005-07 raised mortgage default rates, causing
financial problems for holders of mortgage-backed
securities.
(http://faculty.chicagobooth.edu/raghuram.rajan/research/TheCreditCrisisDougDiamondRaghuRajanAEADec2008.pdf)
How did we get here?
 New loans were risky; but the market should have handled
this. Market participants shared the risks, and they
thought their risks were covered. Markets handle risks
effectively all the time. Why not this time? The market
knew how to handle risks facing a single enterprise -- a
single mortgage borrower, or a single mortgage lender. If a
single mortgage lender had failed, the market could have
handled that.
 But as risks were spread in new ways (or at an
unprecedented scale), there was a heightened danger that a
downturn could pull everybody down at once. Market
participants weren’t hedging against this sort of broad risk,
and it caught them.
(http://www.hbs.edu/research/pdf/09-060.pdf)
How did we get here?
 Consequence: a deep financial crisis
 Lots of uncertainty, so banks and others couldn’t determine
the value of many assets ==> toxic assets.
 Drops in the values of assets eroded bank capital, which
serves as a buffer against losses. Many banks have failed, and
failure has become more likely for many others.
 Banks and other financial institutions became reluctant to
lend or to enter into other transactions, because they could
not judge the soundness of potential borrowers and other
counterparties.
 Facing deep uncertainty, it makes sense for banks to cut their
lending and build their capital back up to comfortable levels.
How did we get here?
Bank Capital as % of Bank Assets
(total equity/total assets)
10.4%
10.2%
10.0%
9.8%
9.6%
9.4%
9.2%
9.0%
8.8%
2003
2004
2005
2006
2007
2008
2009
Data from the St. Louis Fed: http://research.stlouisfed.org/fred2/series/EQTA?cid=93
2010
How does it look so far?
 After 20 months, this recession is already the
longest since the contraction of 1929-1933.
Aug 1929 - March 1933
43 months
Dec 2007 - ??
20 months + ??
Nov 1973 - March 1975
16 months
July 1981 - Nov 1982
16 months
July 1990 - March 1991
8 months
March 2001 - Nov 2001
8 months
Source: http://wwwdev.nber.org/cycles/cyclesmain.html
How does it look so far?
Real GDP
(Billions of chained 2000 dollars, seasonally adjusted)
$14,000
$12,000
billions of 2000 dollars
$10,000
3.1% drop in
last three
quarters
$8,000
$6,000
$4,000
$2,000
$0
1950
1960
1970
1980
Data here and in the following charts from the St. Louis Fed
1990
2000
2010
How does it look so far?
Real GDP growth
(annualized)
20%
15%
10%
5%
0%
1970
-5%
-10%
1975
1980
1985
1990
1995
2000
2005
How does it look so far?
Total Employment Relative to Peak:
The Bad Recessions
102%
1974-75
101%
100%
99%
1981-82
98%
97%
96%
2008-09
95%
-5
0
5
10
15
Months before or after employment peak
20
25
How does it look so far?
U.S. Unemployment Rate
12%
10%
8%
6%
4%
2%
0%
1970
1980
1990
2000
2010
How Bad Might It Get?
 Many economists forecast that the recovery
will start in the third quarter of 2009.
Source: http://online.wsj.com/public/resources/documents/info-flash08.html?project=EFORECAST07
See also:
http://www.nytimes.com/2009/01/03/business/economy/03econ.html?scp=1&sq=blue%20chip%20forecast%202009&s
t=cse
How Bad Might It Get?
Is that too optimistic?
 A recent study of postwar financial crises (plus the
Great Depression) found that recessions tend to be
longer when they accompany financial or banking
crises (like this one).
 The average drop in per capita real GDP was 9.3%. (So
far real GDP has dropped by 1.7% from its peak, and the
consensus forecast predicts a total drop of 3.4%.)
 The average decline in real GDP lasted for 2 years (from
peak to trough). (17 months so far.)
 The unemployment rate rises by an average of 7 percent,
and its rise lasts an average of 4.8 years. (4% rise so far.)
(http://www.economics.harvard.edu/faculty/rogoff/files/Aftermath.pdf)
How Bad Might It Get?
More reasons to temper our optimism:
 This recession is global in scope, so we can’t look
elsewhere (such as strong exports or lending from
abroad) for an easy recovery.
(http://www.imf.org/external/pubs/ft/fandd/2008/12/collyns.htm)
 The scary monster hiding under the bed: Japan in
the 1990s – “the lost decade”
 Housing bubble in late 1980s  bank crisis in 1990s
 Slow growth in real GDP and rising unemployment
throughout the 1990s
(http://www.frbsf.org/econrsrch/wklyltr/2000/el2000-19.html)
How Bad Might It Get?
Japan in
the 1990s:
what we
want to
avoid!
http://www.economist.com/finance/displaystory.cfm?story_id=13415153
How Bad Might It Get?
Japan in the 1990s: what we want to avoid!
How Bad Might It Get?
If I were a betting man…
 The recovery will start later – after the third
quarter of 2009.
 The unemployment rate will set a new post-war
record, passing the old record of 10.8%.
What Should We Do?
History offers lessons:
 Recessions can be long-lasting.
 The Fed did not act decisively in the Great
Depression – it “had to keep its powder
dry for a real emergency.”
 The Japanese government hesitated to
address its bank capital issues in the
1990s, and this seems to have prolonged
its slump.
What Should We Do?
More lessons:
 Sweden and other Scandinavian countries
appeared to find effective remedies in the
early 1990s:
 Governments did not hesitate to act.
 Banks were recapitalized fairly quickly.
 Transparency: government plans were
made public, and bank balance sheets
were objectively assessed.
(http://www.imf.org/external/pubs/ft/fandd/2008/12/ingves.htm)
What Should We Do?
What Should We Do?
 Learning from history:
 The Federal Reserve System is taking extraordinary
steps to rescue the financial system.
 The Fed increased the nation’s money supply at an
annual rate of over 15% from September through
March.
 The Fed has dropped its target interest rate to
essentially zero.
 The Fed has injected hundreds of billions of
dollars into banks, AIG, and other financial
institutions.
(http://www.federalreserve.gov/monetarypolicy/bst.htm)
What Should We Do?
Changes
in the
Fed’s
assets in
the last
two years
(http://www.econbrowser.com/archives/2009/03/the_feds_new_ba.html#more)
What Should We Do?
 Learning from history:
 Emergency Economic Stabilization Act of 2008:
 Troubled Asset Relief Program (TARP) – Treasury
can spend $700 billion to recapitalize banks
 The American Recovery and Reinvestment Act of
2009:
 $787 billion injection of funds into the U.S.
economy, including $212 billion in tax cuts, in the
next ten years
(http://cboblog.cbo.gov/?p=208)
 Projected federal budget deficit for 2009 is $1.7
trillion dollars, or about 12% of GDP.
(http://www.cbo.gov/doc.cfm?index=10014)
For more on this topic:
Links to good background reading:
 From the St. Louis Fed:
http://timeline.stlouisfed.org/
 From the IMF:
http://www.imf.org/external/pubs/ft/fandd/2008/
12/index.htm
 From the U.S. Treasury Department:
http://www.financialstability.gov/index.html