Download Recession in Advanced Economies: A View from the United States

Recession in Advanced Economies:
A View from the United States
Jeffrey Frankel
Harpel Professor of Capital Formation and Growth
The Bellagio Group
Toronto, January 30, 2009
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The return of Keynes
Most economists still shy
away from using the name.
But Keynesian truths abound today:
– Origins of the crisis
– The Liquidity Trap
– Fiscal response
– Motivation for macroeconomic intervention:
to save market microeconomics
– International transmission & coordination
2
Origins
The origin of the crisis was an asset bubble
collapse, loss of confidence, credit crunch.
More like Keynes’ animal spirits
or beauty contest (or Minsky)
than like Friedman-Schwarz
(or monetary models of the last 3 decades).
It was not a monetary cycle -- contraction in
response to inflation (as were 1980-82 or 1991).
But, rather, a credit cycle: 2003-04 monetary
expansion showed up in asset prices
– The BIS got this right (Claudio Borio…).
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Onset of the crisis
Initial reaction to troubles:
– Reassurance in mid-2--7: “The subprime mortgage
crisis is contained.”
It wasn’t.
– Then, “The crisis may stay on Wall Street, sparing
Main Street.”
It didn’t.
– Then de-coupling :
“The US turmoil will have less effect on the rest
of the world than in the past.”
It hasn’t.
By now it is clear that the crisis-turnedrecession is as bad abroad as in the US.
4
US Recession
In December 2008, the NBER Business
Cycle Dating Committee proclaimed the
US peak had occurred December 2007.
Recovery unlikely before late 2009.
– Housing starts at record lows.
– Confidence at record lows…
=> Recession is longest since 1930s.
Could well be as severe as 1980-82.
5
BUSINESS CYCLE REFERENCE DATES
Peak
Trough
Quarterly dates are in parentheses
August 1929(III)
May 1937(II)
February 1945(I)
November 1948(IV)
July 1953(II)
August 1957(III)
April 1960(II)
December 1969(IV)
November 1973(IV)
January 1980(I)
July 1981(III)
July 1990(III)
March 2001(I)
December 2007 (IV)
Average, all cycles:
1854-2001
March 1933 (I)
June 1938 (II)
October 1945 (IV)
October 1949 (IV)
May 1954 (II)
April 1958 (II)
February 1961 (I)
November 1970 (IV)
March 1975 (I)
July 1980 (III)
November 1982 (IV)
March 1991(I)
November 2001 (IV)
(32 cycles)
1945-2001 (10 cycles)
Source: NBER
Contraction
Peak to Trough
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13
8
11
10
8
10
11
16
6
16
8
8
17
10
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US employment peaked in Dec. 2007,
which is the most important reason why
the NBER BCDC dated the peak from that month.
Since then, 2 ½ million jobs have been lost.
Payroll employment series Source: Bureau of Labor Statistics
7
My favorite monthly indicator is
total hours worked in the economy
It confirms: US recession turned severe in September,
when the worst of the financial crisis hit (Lehman bankruptcy…)
8
Recession was soon
transmitted to rest of world:
Contagion: Falling securities
markets & contracting credit.
– Especially in those countries with weak
fundamentals: Iceland, Hungary & Ukraine…
– But even in some where fundamentals were
relatively strong: Korea…
Some others are experiencing their own
housing crashes: Ireland, Spain…
Recession in big countries will be transmitted
to all trading partners through loss of exports.
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Housing bubble burst
10
Housing permits falling almost everywhere
11
OECD forecasts showed its growth approx. flat in 2009
Source: OECD
Economic Outlook
(Nov. 2008).
12
Similarly, World Bank forecasts showed
rich-country growth flat in 2009.
2006 2007 2008* 2009† 2010†
World
Memo item:
World
4.0
3.7
2.5
0.9
5.0
4.9
3.6
1.9
3.9
(PPP wts)
3.0
High-income countries 3.0
2.6
1.3
0.1
2.0
Developing countries 7.7
7.9
6.3
4.5
6.1
•Estimated
(% change from previous year)
† Projected
Source: World Bank, Jan. 2009
13
have now downgraded again
(Jan.28, 09)
14
All large countries in recession
Bank of Japan now expects to contract (1/23/08):
– 1.8 % in year ending March 2008,
– and 2% in the coming year.
Euroland’s recession looks worse
UK ditto: Sir John Gieve (BoE Dep.Gov. 1/16/09) predicted another
steep fall in GDP in Q1 2009, following a decline in the last Q of 2008.
Euro. Comm. : EU growth = -1.8% in 2009. (19 Jan.,09)
Bank of Canada forecasts -2.3% growth, 08 Q4;
followed by
and
- 4.8 % for 09 Q1
-1 % for Q2 (1/22/09 update
to Monetary Policy Report
).
China growth rate probably down by half.
15
Unemployment is rising
€
US
Japan
16
Policy Responses
Monetary easing unprecedented,
appropriately. But it has largely run its course:
– Policy interest rates ≈ 0.
(graph)
The famous liquidity trip is not mythical after all.
– As Krugman & others warned us in re Japan in 90s.
& lending, even inter-bank, builds in big spreads
– since mid-2007, not just since September 2008.
(graph)
Now quantitative easing, as the Fed continues
to purchase assets not previously dreamt of.
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Policy rates have been cut most of the way to zero.
US
€
Japan
18
Bank spreads up
when sub-prime mortgage crisis hit (Aug. 2007)
and up again when Lehman crisis hit (Sept. 2008).
Source:
OECD Economic Outlook
(Nov. 2008).
19
Corporate spreads
between corporate & government benchmark bonds
zoomed after Sept. 2008
US
€
20
Policy Responses,
continued
Likely Obama policy of “financial repair”:
Infusion of funds will be more conditional,
– Vs. Bush Administration’s no-strings-attached.
– Some money goes to reduce foreclosures.
– I’d consider imposing on banks that want help:
(1) no-dividends rule,
(2) more serious curbs on executive pay, &
(3) no takeovers, unless at request of authorities
21
Policy Responses,
continued
The TARP keeps evolving
First unspecific,
then to buy toxic loans,
then to recapitalize banks,
then auto bailout,
Now up in the air:
– insure banks’ toxic assets rather than acquire them?
– create “bad bank” as in “Swedish model”?
– outright nationalization not yet under consideration in US.
22
Policy Responses,
continued
Unprecedented US fiscal expansion,
most of which is still to come.
– Obama proposed an $825 expansion
– House passed a version. Senate will soon.
– Good old-fashioned Keynesian stimulus
Even the belief that spending provides
more stimulus than tax cuts has returned
– not just from Larry Summers, for example,
– but also from Martin Feldstein.
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“Timely, targeted and temporary.”
American Recovery & Reinvestment Plan includes:
– Aid to states: education, Medicaid…;
– Other spending.
Unemployment benefits, food stamps,
especially infrastructure, and
– Computerizing medical records, smarter electricity
distribution grids, and high-speed Internet access.
– Tax cuts (unfortunately still distorted by politics)
Cut for lower-income workers
– EITC, child tax credit, payroll tax holiday.
Other (less well-targeted) tax cuts
demanded by Congressional Republicans
Hopefully a fix for the AMT.
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Motivation for macroeconomic intervention
The view that Keynes stood for
big government is not really right.
– He wanted to save market microeconomics from
central planning, which had allure in the 30s & 40s.
Some on the Left today reacted to the crisis &
Obama’s election by hoping for a new New Deal.
– My view:
faith in unfettered capitalist system has been
shaken with respect to financial markets, true;
but not with respect to the rest of the economy;
– Obama’s economics will be centrist, not far left.
25
International transmission
As noted, international
transmission remains powerful
– Despite floating exchange rates
– Consistent with old-fashioned Keynes-MeadeMundell-Fleming transmission via trade
balances.
26
Global Current Account Imbalances
will probably now be forced to adjust
US deficit will likely diminish,
– though adjustment requires $ depreciation.
Who must take corresponding reduction
in current account surpluses?
– Europe says: “Not us. Overall we are in balance.”
– Others say: Europe can expect to take a share,
roughly proportionate to its share in world trade,
especially in light of strong €,
regardless starting position of CA.
– IMF seems to think oil exporters will take all adjustment
(see graph)
27
Current account adjustment:
US vis-á-vis oil exporters
(as % of GWP;
source: IMF)
28
But the OECD sees the €-area bearing almost as
much of the adjustment as non-OECD countries.
Source: OECD Economic Outlook, Nov. 2008.
3/ as % of GDP
29
Fiscal expansion internationally
EU agreed 1.5% GDP expansion in Dec.
– More coming?
Most other countries as well
China
– Is the most obvious candidate for fiscal expansion.
– What PRC has announced is less than it sounded.
– Fiscal expansion & development of health care,
pensions, etc., would be a more productive topic for
international discussion than RMB “manipulation”.
30
International coordination
of fiscal expansion?
As in the classic Locomotive Theory
Theory: in the Nash non-cooperative equilibrium
each country fears expanding fiscally for fear of
adverse trade deficit.
– Solution: A bargain where all expand together.
In practice: example of Bonn Summit, 1978
– didn’t turn out so well,
– primarily because inflation turned out to be a bigger problem
than realized (& German world was non-Keynesian).
– That is less likely to be a problem this time.
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