Transcript Topic1 - Stanford University

Summer Institute at Stanford
Monetary and Macro Policy
2008-2012
Prof. Pete Klenow
[email protected]
1
Table of Contents
The Great Recession
4–7
Proximate Causes
8 – 14
Monetary Policy Response
16 – 37
Fiscal Policy Response
38 – 54
Lingering Unemployment
55 – 57
The Fiscal Cliff
58 – 66
2
Key Questions
Did Macro Policy prevent a Great Depression?
Have unconventional Monetary Policies helped the recovery?
Did the Fiscal Stimulus Package create or save 3.5m jobs?
Why is unemployment still so high?
The Fiscal Cliff: bad for 2012 but good for 2020 and beyond?
3
4
5
6
7
Proximate Cause of Great Recession?
Conventional Keynesian view: plummeting demand for goods.
Delinquencies on mortgages  falling construction.
Decline in bank net worth  tighter credit.
Decline in household net worth  debt deleveraging.
Why longer-lasting than the 2001 Dot Com Crash?
8
Employment vs. Initial Debt/Income
9
10
Why might demand drive Y, N?
Sticky Prices
Many prices change once a year or less.
Sticky Wages
Many wages change less than once a year.
Downward nominal rigidity.
What did Stanford do?
11
Alternative Views
Great Recession lasted too long to be b/c of stickiness.
Zero Lower Bound put a floor under real interest rate.
Unemployment benefits were extended.
Mismatch in the labor market (construction vs. health).
Increase in uncertainty (partly about macro policy).
Where do most macroeconomists come down?
12
Macro Advocates
Embracing conventional Keynesian wisdom:
The President’s advisers (Summers, Romer, Goolsbee)
Economic Experts Panel
Krugman, Stiglitz, Mankiw, Rogoff
Contrarians:
Taylor
Barro
Cochrane
Media coverage?
13
Monetary and Fiscal Policy Responses
Fall 2008: TARP (~5% of GDP, eventually closer to 3%)
QE 0 (~3% of GDP)
QE 1 (~4% of GDP)
Spring 2009: Fiscal Stimulus (~5% of GDP over three years)
QE 1 scaled up (to > 8%)
Fall 2010: QE 2 (~4% of GDP)
Fall 2011: Operation Twist (~3% of GDP)
Which has done more, monetary or fiscal policy?
14
With vs. Without Policy Responses
Fall in real output (relative to trend) of ~ 10% of GDP
Keynesians think policy prevented GDP from falling 5% more.
If so, real output would have fallen at least 15% without policy.
A Great Depression? A Depression?
15
Conventional Monetary Policy Response
First thing the Fed did was buy T-bills galore.
This flooded banks with reserves.
Pushed down the federal funds rate
(interest rate on overnight loans of reserves between banks).
Goal:
Push down real interest rates facing households, firms.
Boost private spending on consumer durables, investment.
Lift real output and employment.
16
17
Was conventional MP enough?
Typical estimate: 1% cut in real FFR  0.5% higher Y.
Nominal FFR fell about 5%.
Expected inflation fell roughly 1%.
So real FFR down 4%  2.0% boost to Y.
But unemployment soaring. “Spreads” rising.
Real interest rates were not falling for firms and households.
Pushing on a string?
18
The Taylor Rule
*


Y

Y
*
i  r    a      b 
 residual

*
 Y 
*


Y

Y
*
 r  r  a      b 
  residual
*
 Y 
i  FFR, r  real FFR, r  average real FFR
What did it say in 2009 ?
*
Y

Y
r  2%,  *  2%,   1%,
 9%, a  0.5, b  0.5
*
Y
 i  2%, r  3%
19
The Zero Lower Bound
The Central Bank cannot drive i below 0.
If i is fixed at 0, r increases when the inflation rate falls.
Deflationary death spiral:
Deflation raises r which cuts into goods demand (C, I).
The rise in the real value of debts may also cut demand.
The drop in SR Y generates more rapid deflation.
This is Central Bankers’ greatest fear. Why?
20
TARP
Lehman went bankrupt. Markets freezing up.
Other banks looked like they could fall too.
No Chapter 11.
TARP made loans, equity investments in financial institutions.
Initially considered 50% gift, 50% investment.
Opposed by many economists. Why?
21
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Ben Bernanke’s Moment
Made his academic reputation on two ideas:
1. Bank failures caused the Great Depression.
2. The Financial Accelerator
As member of Fed in 2003, chided Bank of Japan.
Advocated unconventional steps to combat deflation.
What was Bernanke’s nickname?
23
Unconventional Monetary Policy
Lehman bankruptcy hobbled the Commercial Paper market.
So the Fed bought all newly-issued paper at end of 2008.
Made emergency loans to banks.
Investment banks hastily obtained bank charters.
Fed is still getting flak for keeping loans anonymous.
QE 0?
24
Fed Starts Paying Interest on Reserves
Asked Congress for authority in fall of 2008.
Started paying interest soon after.
Wait, doesn’t this just encourage banks to sit on cash?
So why did the Fed do it?
25
Fed’s QE 1 and 2
QE 1: In early 2009, announced plans to buy ~4% of GDP
worth of mortgage-backed securities. Later doubled.
Originally planned to buy many other private assets.
Why didn’t it? Agency debt guaranteed by the Treasury.
QE 2: Rolled maturing mortgages over into Treasury bonds.
Bought more LT Treasury bonds. Totals ~4% of GDP.
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What the Fed thinks QE achieved
Lowered nominal interest rates on private borrowing ~ 50 bp
Boosted inflation ~ 1 percentage point (good because prevented
inflation from falling farther below target)
Lowered real interest rate on private borrowing ~ 1.5 % points
Lowered unemployment rate ~ 1.5 percentage points
Boosted real output ~ 3 percentage points, jobs by 3 million
Source: Federal Reserve study
28
Critics of Quantitative Easing
Didn’t work.
– The extra liquidity remained trapped in the banking system
rather than being lent out (Liquidity Trap)
Misallocated capital (didn’t get to constrained small borrowers)
Sowed the seeds for inflation down the road.
Sacrificed Fed credibility and independence.
Punch Bowl?
29
30
31
Operation Twist
In 2011 Fed announced plans to buy long-term Treasury bonds.
… and simultaneously sell short-term Treasury-bills.
Leaving total bank reserves unchanged (hence not QE).
So how could it work? Preferred Habitat Theory
What has the Treasury been doing?
32
QE 3?
Inflation remains “well-anchored” near 2%.
Unemployment, at 8%, remains above Fed’s estimate of the
“natural rate” (around 6%).
Weak jobs and other data  building pressure on the Fed.
What might prevent the Fed from acting?
33
Unwinding
What if banks start lending their free reserves out, could cause
demand for goods and inflation to soar.
Fed may want to “drain” liquidity (reduce reserves) in response.
How to do it? Any new tools?
34
The Fed’s Dream Balance Sheet …
Under Conventional Monetary Policy:
Fed received interest on U.S. government securities.
Paid no interest on its liabilities (currency and fed funds).
What about under Unconventional Monetary Policy?
35
… is now a Nightmare?
36
Should the Fed raise its Inflation Target?
Pros
Cons
37
2009 Fiscal Stimulus Package
60% higher spending (mostly transfers)
Evidently not many shovel-ready infrastructure projects
Transfers to states may have prevented deeper state G cuts
40% lower taxes
Ramped up from 2009-2010.
Leveled off or phased out?
38
39
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CBO on Fiscal Stimulus
Assumed multiplier ranged from 0.5 to 1.5.
1.2 to 3.6 million jobs created or saved.
41
Old Keynesian Multiplier
Suppose MPC = 1  s    m.
s  marginal saving rate
  marginal tax rate
m  marginal spending on imports
Then, under strong assumptions,
Y
1

G s    m
Y
1

1
T s    m
42
Assumptions for Old Keynesian Multiplier
1. Sticky prices so demand drives production:
Y  C  I  G  NX and RHS  LHS
No shortage of K or N to meet Y demand.
2. I  EX is fixed.
3. MPC is fixed and not forward looking.
43
New Keynesian SR Multiplier
Consumers are forward-looking (ΔC = ΔLifetimeY/Lifespan).
↑ expected future T → may see ↓ C today
Investment responds to real interest rate
If ↑ deficits → ↑ present or future rates, may see ↓ I today
There is no single New Keynesian Multiplier. It depends on
how permanent the stimulus is, how it is financed, and how the
Central Bank responds.
Can one get a multiplier < 1? < 0?
44
Fiscal Stimulus and the Evidence
Suppose you don’t care for economic theory or models
(no matter the corroborating evidence for their ingredients).
What does direct evidence from past episodes say?
Romer and Romer: multiplier > 1 for lower T.
Barro: < 1 judging from U.S. wars (higher defense G)
Parallel Universe Machine?
45
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Fiscal Stimulus at the ZLB
In conventional New Keynesian models, the Central Bank is
trying to stabilize real output (relative to trend) and inflation.
The Central Bank may offset the effects of a Fiscal Stimulus,
thereby lowering the multiplier.
But U.S. economy at Zero Lower Bound since late 2008.
Stuck to the floor  no offset from the Fed?
Upshot: Multiplier could be much larger at the ZLB.
Extent of QE if there had been no Fiscal Stimulus?
47
Cross-State Evidence on Fiscal Stimulus
A number of studies have found big multipliers looking
across U.S. states.
Would have expected low cross-state multipliers given
states are very “open” and labor is not very mobile.
No Monetary Policy offset across states – just like ZLB?!
What if Monetary Policy offset national stimulus?
48
Hall’s estimates
49
Skeptics on Fiscal Stimulus
Under flexible prices, multiplier is closer to 0 than 1.
Additional G might be wasteful.
And stuck with it far into the future.
Better to rely on the Fed.
Not powerless, less political, easier to reverse.
Deadweight loss from raising marginal tax rates later.
50
Did cash for clunkers stimulate C?
51
Did the overall 2009 C stimulus work?
52
2008 Stimulus Checks
53
Payroll Tax Cuts
Reduced the employee portion.
But arguably should have reduced the employer portion.
Would lower the cost of labor to firms.
Would encourage hiring.
Could mimic downward wage flexibility.
Phase it out as unemployment returns to normal.
54
Why is unemployment stubbornly high?
Republicans
• high unemployment benefits
• uncertainty about government policy
• mismatch / geographic immobility
55
56
Why is unemployment stubbornly high?
Democrats
• Lack of goods demand
-- Sticky prices
-- Zero Lower Bound
• Sticky Wages
57
The Fiscal Cliff
Taxes up around 3% of GDP
• Expiration of 2% payroll tax cut
• Top income tax rate 35%  40.6%
• Top dividend tax rate 15%  43.4%
• Top capital gains tax rate 15%  23.8%
• Top estate tax rate 35% (+5M) 55% (+1M)
• Expansion of AMT
Spending down 0.7% of GDP
• Automatic cuts of $98B.
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Labor Tax Laffer Curves
62
Capital Tax Laffer Curves
63
Public Debt Crises
The higher is B/(PY), the more debtholders worry the
government will default or try to inflate their way out:
B
correlation(i,
)0
PY
This can be self-fulfilling: the higher the default premium,
the more tempted the government is to default.
Austerity or Default?
64
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Fiscal Moment of Truth
Benefits to acting sooner:
1. Avoid more fiscal austerity later.
2. Prevent a debt crisis
3. Create Fiscal Space
What would you do to fix the budget?
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