Download Economic Outlook 2013 - Rensselaer Hartford Campus

Understanding the Financial Crisis
Presentation to
Students & Friends of Rensselaer Hartford
Hartford, CT
James Stodder, (Ph.D., Economics, Yale 1990)
Lally School of Management & Technology
Rensselaer Polytechnic Institute at Hartford
Hartford, Connecticut, USA
Tuesday, May 23, 2017
1
Outline of Talk
1.
Keynes on Credit Cycles:
- Why we need Regulation
2.
3.
4.
Where is the Bottom?
Connecticut is “Middle of the Pack”
Government Deficit Spending
a.
b.
Needed in the Short-term
But a Big Problem Long-term
Tuesday, May 23, 2017
2
(1) Biz & Credit Cycles
J. M. Keynes: 1883-1946
Tuesday, May 23, 2017
3
US Macro-Stability:
Better, Room for Improvement
Average U.S. Business Cycle, 1854 to 2006
Contraction
1854-1919
(16 cycles)
45%
1919-1945
(6 cycles)
55%
34%
1945-2006
(10 cycles)
66%
15%
0
Expansion
85%
10
20
30
40
50
60
70
Months
Source:
Tuesday, May 23, 2017
http://www.nber.org/cycles.html
4
Bad News: Bubbles are Endemic
Tuesday, May 23, 2017
Arlington Williams, “Price Bubbles”
www.indiana.edu/~arlwilli/pdf%20files/bigmkts.pdf
5
Good News: People Do Learn
V. Smith & A. Williams,
“Experimental Market
Economics,” Scientific
American, Dec. ‘92
Tuesday, May 23, 2017
6
Price/10 Year Avg. Earnings
Source: http://www.econ.yale.edu/~shiller/data.htm
Tuesday, May 23, 2017
7
The Wisdom of Keynes
“A sound banker, alas, is not one
who foresees danger and avoids
it, but one who, when he is ruined,
is ruined in a conventional way,
along with his fellows, so that no
one can really blame him.”
- J.M. Keynes (1931)
Tuesday, May 23, 2017
8
“Paradox of Thrift” Keynes noted:
Consumers cut back on their spending
and save more during a recession. This
only makes the recession worse.
Similarly for Banks, Loan Loss Reserves
(LLR) are often raised in a recession, just
when households and businesses most
need credit –ensuring more collapses and
worsening the recession.
Tuesday, May 23, 2017
9
Insurance => Moral Hazard =>
Necessity of Regulation
Moral Hazard of Insurance:


If you had a car that is less damaged
by any given car crash – would that
make you drive faster?
If you (and everybody else) drove
faster, could this actually wind up
making you less safe ?
Tuesday, May 23, 2017
10
www.economist.com/finance/displaystory.cfm?story_id=12480887
www.nytimes.com/2008/10/03/business/03sec.html
Tuesday, May 23, 2017
11
Availability of Bank Loans
Tuesday, May 23, 2017
12
Currency & Reserves Up 4x
Oct. 17, 2012
Tuesday, May 23, 2017
http://research.stlouisfed.org/fred2/series/BASE
13
But Bank Reserves up 100x
Oct. 17, 2012
Tuesday, May 23, 2017
http://research.stlouisfed.org/fred2/series/WRESBAL
14
M0 = Currency + Bank Reserves ≈ $2.6t
Oct. 17, 2012
Tuesday, May 23, 2017
http://research.stlouisfed.org/fred2/series/BASE
15
M1 ≈ $2.4t = Currency + Bank Deposits
Oct. 17, 20112
Tuesday, May 23, 2017
http://research.stlouisfed.org/fred2/series/M1
16
Money Mult. = M1/M0 ≈ 2.4/2.6 = 0.92
Oct. 17, 2012
Tuesday, May 23, 2017
http://research.stlouisfed.org/fred2/series/MULT
17
Bank Money Multiplier
If l = % loans, Reserve multiplier is
D = R(1+ l
+ l +… + l
2
∞ )= R/(1-
l)
If M0 = Currency (C) + Reserves (R),
M1=Currency + Deposits, so:
M1 = C + R/(1- l ) = M0–R+ R/(1- l )
M1/M0 = 1+{-R + R/(1- l )}/M0
So M1/M0 < 1 =>
Tuesday, May 23, 2017
l<0
18
Limits of Fed Magic
Tuesday, May 23, 2017
New Yorker, Oct. 2008
19
The Zero Bound
Oct. 17, 2012
Tuesday, May 23, 2017
http://research.stlouisfed.org/fred2/series/TB3MS
20
The Zero Bound (2)
Oct. 17, 2012
Tuesday, May 23, 2017
http://research.stlouisfed.org/fred2/series/FEDFUNDS
21
The Zero Bound (3)
T.I.P.S.
Tuesday, May 23, 2017
22
Quantity of Money Equation
M*V ≡ P*Y
Money * Velocity ≡ Price * Output =>
ln(M) + ln(V) = ln(P) + ln(Y) =>
i.e.,
Tuesday, May 23, 2017
%∆M
+ %∆V = %∆P + %∆Y over time
23
%∆ Money Turnover [ = %∆ (Money x Velocity) ]
is Too Pro-Cyclical because of Velocity
% ∆ (M x V)
% ∆M
%∆V
23-May-17
24
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
Tuesday, May 23, 2017
25
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment
Investment Demand = Savings
interest
interest
rate
rate
MONETARY Expansion:
Money Demand = Supply
Supply
GDP
GDP
Tuesday, May 23, 2017
26
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
Tuesday, May 23, 2017
27
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
Tuesday, May 23, 2017
28
Keynesian Multiplier: Evidence
Source: IMF World Economic Outlook and IMF Fiscal Monitor, Oct. 2012
Tuesday, May 23, 2017
29
Another Illustration: Multiplier > 1
Tuesday, May 23, 2017
30
NY Times, Oct. 23, 2012
Okun’s Law (1): Unemployment Gap
Oct. 24, 2012
Tuesday, May 23, 2017
31
Okun’s Law (2): Output Gap
Oct. 24, 2012
Tuesday, May 23, 2017
32
Okun’s Law (3)
Tuesday, May 23, 2017
33
Okun’s Law (4)
Oct. 17, 2012
Tuesday, May 23, 2017
34
Output Gap ≈ 20% GDP

http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08Outlook_Testimony.pdf
A little Stimulus Math:
20% * $14 tr. = $2.8 tr.
Stim*1.5 = $2.8 => Stim = $1.87 tr.
Tuesday, May 23, 2017
35
(2) Bottom Still a Ways Off





Okun’s Law, and Slow Recovery
Housing Recovery probably still a
year away.
Credit Markets still very weak.
Stock Market Valuation Ratios like
P/E and Tobin’s Q are now only at
historical averages.
Unemployment Trend:
http://cr4re.com/charts/charts.html
Tuesday, May 23, 2017
36
Housing Bottom – A Long Way Off
http://www.nytimes.com/imagepages/2008/10/16/business/16housing.graphix.ready.html
Tuesday, May 23, 2017
37
Why it Matters to Everyone
Tuesday, May 23, 2017
38
Worst Long-Term Unemployment
Oct. 17, 2012
Tuesday, May 23, 2017
http://research.stlouisfed.org/fred2/series/UEMPMEAN
39
Long Unemployment Dip
Tuesday, May 23, 2017
http://cr4re.com/charts/charts.html
40
(3) CT & NY in “Middle of Pack”





Financial Sector down, but ..
Conventional Banking and Insurance
less vulnerable than Investment
Banks, Financial Insurance
Defense industries well insulated
Pharmaceuticals and Biotech have
good long-term prospects
House Price Increases near US Avg.
Tuesday, May 23, 2017
41
International Housing Prices
Tuesday, May 23, 2017
42
Sun Belt, Rust Belt Concentration
Tuesday, May 23, 2017
43
2006 Peak of Price-to-Rent
Tuesday, May 23, 2017
44
Tuesday, May 23, 2017
Source: NY Times, April 20, 2010
45
(4) More Federal Deficit Spending
(not Tax Cuts) Necessary



Tax cuts to the rich more likely to be
saved, not spent or invested.
Tax cuts don’t have big effect on
those too poor to pay many taxes.
Unmet needs in Energy, Environment,
Health, and Education: good reasons
to spend.
Tuesday, May 23, 2017
46
Government Must Increase
Spending in Severe Recession
“ If the Treasury were to fill old bottles with
banknotes, bury them at suitable depths
in disused coal mines …
It would, indeed, be more sensible to build
houses and the like; but if there are
political and practical difficulties in the
way of this, the above would be better
than nothing.” (Keynes, General Theory, 1937)
Tuesday, May 23, 2017
47
But We Need Foreign Coordination
for US Expansion to be Successful



Benefits of lone expansion “leak out,”
other countries free ride.
Alternatives to joint expansion are
protectionism and competitive
devaluations.
US long-term “Fiscal Gap” makes
lone expansion untenable.
Tuesday, May 23, 2017
48
Long Term Fiscal Gap: Unsustainable
http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
Tuesday, May 23, 2017
49
Sure as Debt and Taxes
http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
Tuesday, May 23, 2017
50
Implications of Limited Pass-Through
Linda Goldberg (FRBNY) has shown that
Dollar Devaluation means:
• Improved Earnings on Foreign Assets
• Easier Debt Servicing
• Smaller Trade Deficit
And at the same time,
• Minimal Costs in further Inflation
So - What’s Not to Like?
• FRBNY Governor Frederic Mishkin says
“Devaluation cannot be a policy.” (I think he
means an explicit policy.)
Tuesday, May 23, 2017
51
The Zero Bound (3)
T.I.P.S.
Tuesday, May 23, 2017
52
Inflation/Devaluation
a Powerful Temptation for
Highly Indebted Governments
•
•
•
•
Germany after WWI
Russia after the Revolution
Soviet Union after the Cold War
Many Developing Countries after
spending, investment binges
(See L. Kotlikoff & S. Burns,
The Coming Generational Storm, 2004)
Tuesday, May 23, 2017
53
Implications of Limited Pass-Through
Linda Goldberg (FRBNY) has shown that
Dollar Devaluation means:
• Improved Earnings on Foreign Assets
• Easier Debt Servicing
• Smaller Trade Deficit
And at the same time,
• Minimal Costs in further Inflation
So - What’s Not to Like?
• FRBNY Governor Frederic Mishkin says
“Devaluation cannot be a policy.” (I think he
means an explicit policy.)
Tuesday, May 23, 2017
54
Inflation/Devaluation Appears
a “Painless” Way Out of Debt
Tuesday, May 23, 2017
55
Summary of Conclusions




Recession is long and deep: housing slump,
interbank lending, financial markets likely to
“overshoot” on low side.
CT, NY are “middle of the pack” for housing
prices and employment stability.
Greatly expanded federal spending is needed
in the short-term.
Long-term, however, US government debt is
unsustainable.
Tuesday, May 23, 2017
56