Transcript Economic Outlook Presentation to Workers’ Compensation Trust

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
Friday, July 17, 2015
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.
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Needed in the Short-term
But a Big Problem Long-term
2
(1) Biz & Credit Cycles
J. M. Keynes: 1883-1946
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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:
Friday, July 17, 2015
http://www.nber.org/cycles.html
4
Bad News: Bubbles are Endemic
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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
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6
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)
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7
“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.
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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 ?
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9
www.economist.com/finance/displaystory.cfm?story_id=12480887
www.nytimes.com/2008/10/03/business/03sec.html
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10
Availability of Bank Loans
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11
Currency Rises Slightly
Aug. 2010
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12
But Bank Reserves up 100-fold
Sept.2010
16, 2009
Aug.
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13
M0 = Currency + Bank Reserves ≈ $2.0t
Aug. 2010
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14
M1 ≈ $1.7t = Currency + Bank Deposits
Aug. 2010
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15
Money Mult. = M1/M0 ≈ 1.7/2.0 = 0.85
Aug. 2010
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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
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So M1/M0 < 1 =>
l<0
17
Limits of Fed Magic
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New Yorker, Oct. 2008
18
The Zero Bound (1)
Aug. 2010
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19
The Zero Bound (2)
Aug. 2010
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20
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
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21
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment
Investment Demand = Savings
interest
interest
rate
rate
MONETARY Expansion:
Money Demand = Supply
Supply
GDP
GDP
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22
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
Friday, July 17, 2015
23
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
Friday, July 17, 2015
24
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.
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(2) 3 Reasons Bottom still
A Long Way Off



Housing Recovery probably still more
than 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.
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Housing Bottom – A Long Way Off
http://www.nytimes.com/imagepages/2008/10/16/business/16housing.graphix.ready.html
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27
Why it Matters to Everyone
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28
TED-Spread & Financial Crises
3.00
2.50
Subprime
financial
shock
2.00
1.50
S&L crisis
1.00
Orange
County
Peso
crisis
LTCM
Thai
baht
Y2K
Tech
bust
0.50
0.00
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
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108 Years of P/E and Q
Shiller/Smithers - www.ft.com/cms/s/0/099f6380-bb1f-11dd-bc6c-0000779fd18c.html
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30
(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.
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31
International Housing Prices
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32
Sun Belt, Rust Belt Concentration
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33
2006 Peak of Price-to-Rent
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34
Friday, July 17, 2015
Source: NY Times, April 20, 2010
35
Housing Prices in Northeast
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36
Median Price, Existing Single-Family Homes,
Metropolitan Area
NY & CT ($1,000)
2007
2008
2009
2010.II p $ Since '07 % Since '07
Albany-Schenectady-Troy, NY
$199
$198
$189
$194
-$5
-2%
Binghamton, NY
$111
$114
$116
$111
$0
0%
Buffalo-Niagara Falls, NY
$104
$105
$114
$121
$17
17%
Elmira, NY
$82
$88
$87
$99
$18
22%
Glens Falls, NY
$168
$161
$154
$148
-$19
-12%
Kingston, NY
$258
$242
$208
$208
-$50
-19%
NY: Nassau-Suffolk, NY
$477
$436
$383
$395
-$82
-17%
Rochester, NY
$118
$117
$116
$121
$4
3%
Syracuse, NY
$122
$120
$121
$125
$4
3%
Bridgeport-Stamford-Norwalk, CT
$487
$438
$379
$419
-$67
-14%
Hartford-West Hartford-East Hartford, CT
$263
$246
$232
$236
-$27
-10%
New Haven-Milford, CT
$287
$264
$236
$238
-$49
-17%
Norwich-New London, CT
$268
$237
$212
$224
-$44
-16%
http://www.realtor.org/research/research/metroprice
Friday, July 17, 2015
www.bos.frb.org
37
(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.
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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)
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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.
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40
Long Term Fiscal Gap: Unsustainable
http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
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41
Sure as Debt and Taxes
http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
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42
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)
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43
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.)
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44
Inflation/Devaluation Appears
a “Painless” Way Out of Debt
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45
Promising Investments?
Medium-Term Holds (Very Cautious):

US Treasuries (but not long term – remember inflation)

Gold, Silver, other precious metals
Long-Term Holds (Patient):

Non-Dollar Assets in Emerging Markets

Renewable Energy Technology

Pharmaceuticals: tied to incomes in emerging markets
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Summary of Conclusions





Recession will be 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.
There are still some places to put your
money
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