Download On Efficiently FDinancing Retirement

Money, Financial Crises, and
Business Cycles
Edward C. Prescott
July 7, 2010
Messages
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Monetary Policy has little real effects
Financial crises are symptoms and not cause of
economic downturns – crises sometimes lead to good
regime changes and sometimes to bad
A big looming problems is efficiently financing
retirement consumption – it can be done
2
Macro Theory Works
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Given productivity, population, and taxes:
– Predicted and actual paths of the aggregate variables
coincide
– All using dynamic economic theory to construct
models consistent with the national accounts and
other data find same thing
– All find monetary policy had little real impact
3
What Gave Rise to Post 1960 Contractions
and Expansions?
• All graphs per working-age person and adjusted for
secular living standard growth
•
Flat line is healthy trend growth with living standards
doubling every generation
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The Biggest Expansion
Technology Driven
110
Period Average = 100
105
100
95
* Quarterly trend growth: 0.45%
90
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
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The Biggest Contraction
Tax Rate and Productivity Driven
110
Period Average = 100
105
100
95
* Quarterly trend growth: 0.45%
90
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
6
The Longest Expansion
Tax Rate and Productivity Driven
110
Period Average = 100
105
100
95
* Quarterly trend growth: 0.45%
90
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
7
The 1990s Expansion
Technology Driven
110
Period Average = 100
105
100
95
* Quarterly trend growth: 0.45%
90
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
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Best Indicator of Current Situation is Market
Hours, Not GDP!
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I use household survey measures of hours worked
(CPS)
There are serious problems with establishment based
hours estimates
GDP is only part of output and is revised in major ways
as more data becomes available
CPS market hours are revised little
US Annual Hours per Working Age Person
2001-I to 2010-I
1600
Peak: 2008-II
1500
1400
1300
Trough: 2009-III
1200
2001-I
2003-I
2005-I
2007-I
2009-I
Source: Cociuba (FBR Dallas), Prescott (ASU & FBR Minn.), and Ueberfeldt
(Bank of Can.)
Hours Drop between 2008.II and 2009-III
11 %!
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Has Output Started to Recover?
NO!
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Businesses have cut intangible capital investment
– R&D, human capital investment, advertising
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Intangible investment is not part of measured output
– because it is expensed
Output = GDP + Intangible capital investment
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Preliminary detrended GDP flat last three quarters
Detrended output almost surely fell
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Note: Fluctuations Not Due to Monetary
Policy!
• Nor lack of borrowing
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Liabilities of Households and of
Nonfinancial Businesses They Own
End 2007 End 2008
Total Liabilities
(trillion US$)
End 2009
32.5
33.2
32.9
Mortgages
44.9%
44.4%
43.1%
Business Borrowing
38.3%
39.5%
39.3%
Other
16.8%
16.1%
17.6%
Composition Shares
Source: Flow of Funds, March 11, 2010 Release, Tables L100 and L101
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Reason for Not so Great Current Depression is
NOT Recent Financial Crisis!
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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
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Problem: Banks do not have good lending opportunities
Then What Depressed the U.S. Economy
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Fact: Investment suddenly became depressed beginning
early in 2008 – because of a policy regime change
Business owners feared higher tax rates with the regime
change and
– Rationally cut investment
– Rationally cut employment
– Rationally took more cash out of business
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Workers fearing job loss rationally cut auto buying
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Private Investment Is Depressed (2006 Q4 = 1)
1.4
1.2
G/Y
C/Y
1
Y GDP
C Private Consumption
I Private Investment
G Government Expenditures
0.8
0.6
0.4
2001
2002 2003
2004 2005
2006 2007 2008
I/Y
2009
Fears Are Being Realized
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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
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What Happened after Financial Crises?
Sometimes bad things
and
Sometimes good things
Numbers are trend corrected so flat line is growing at trend
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Finland Good and Japan Bad
GDP per Capita Detrended at 2% 1992 = 100
140
Finland
120
100
80
60
Japan
Source: GGDC (PPP-EKS)
1990
1994
1998
2002
2006
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Chile Great and Mexico Terrible
Detrended at 2% 1980 = 100
140
Chile
120
100
Mexico
80
Source: GGDC (GK-PPP)
60
1980
1984
1988
1992
1996
2000
2004
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Others Financial Crises
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U.S. 1981:
good policy regime change
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U.S. 1989-90 :
bad change
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Asia 1997 :
good change
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U.S. 2008 :
bad change
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Euro Zone 2010: probably good change
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What are Good and Bad
Policy Regime Changes?
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Good: Cut tax rates and therefore expenditures; Follow
productivity growth policies
Bad: increase expenditures and therefore taxes now
and/or in the future; cater to special interest groups
which blocks productivity growth
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A Looming Financial Problem:
Financing Retirement Consumption
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The ratio of retirees to workers is going up
Can’t increase transfers to old because higher tax rates
will not increase revenue
With current tax system there will be an overaccumulation of capital and dynamic inefficiency
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U.S. Has a Big Capital Stock:
5.8 GNPs
Legal Ownership
Stock
Source
Government
0.6 GNPs
BEA
Tangible Private
3.5 GNPs
BEA
Intangible Private
1.7 GNPs
McGrattan &
Prescott, AER,
Sept 2010
Total
5.8 GNPs
But, most is Owned by the Government
Economic
Ownership
Stock in GNPs
Government
3.0
Private
2.8
Total
5.8
What Can Be Done?
Answer: Eliminate taxes on capital income!
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Will increase private saving stock net of government
debt
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Will increase the market value of businesses by
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– Shifting most of its ownership from the public to
private sector
Will increasing private saving opportunities
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Legal and Economic Ownership are Different
Concepts and it is the Economic Concept that
must be Used in Economic Analyses
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Economic ownership of a stream of distributions means
that the owner can transform this stream into an equal
valued stream of consumption
If 50% of a legally owned stream is taken as taxes,
economic and government ownership are both 50%
The tax on pension payments is approximately 50% in
the U.S. so the government owns half our pension
savings
There are Solutions to the Problems
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The Saving for Retirement Problem
– Solution – Shifting economic ownership of a large
part of the capital stock from the public to the private
sector by eliminating capital income taxes
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The Current U.S. Depression
– Cut tax rates and expenditure and stop catering to the
special interests groups