Transcript Great Recession

The “Great Recession”:
Economic Crisis & Crisis in
Economics
Sasan Fayazmanesh
October 11, 2012
Summary
This presentation deals with the US economic crisis that
began in 2008, as well as the crisis in economic theory.
It is argued that while the recent crisis was not a
depression and hardly comparable to the Great
Depression, it was a “Great Recession.”
Moreover, the Great Recession brought to the fore the
underlying crisis in economics.
See Paul Krguman, End This Depression Now! 2012
In particular, I will look at:
• The rate of growth of GDP, unemployment rate
and bank failures since the beginning of the crisis
• The timeline of the crisis
• The problem of causation and economic theory
But before all this:
“Economics 101”
Q: What is the difference between a
recession and a depression?
GDP
Recession
(2 quarters decline in GDP)
Business Cycle (Trade Cycle)
Historical
Time
GDP
Depression!
(A “severe” recession)
Historical
Time
Long Waves (Kondratiev waves)?
The Great Depression (1929-1939)
By 1933:
1) There was no new investment
2) GDP was down by 1/3
3) Unemployment was at 24%
4) Nominal wages and prices were down by 1/3
5) The banking system collapsed, after nearly
11,000 banks closed in the US (40% of all banks)
6) Stocks lost 90% of their values
Q1: Was the downturn in 2008 the
beginning of a depression?
Q2: Are we currently in a recession?
Year
2007q4
2008q1
2008q2
2008q3
2008q4
2009q1
2009q2
2009q3
2009q4
2010q1
2010q2
2010q3
2010q4
2011q1
2011q2
2011q3
2011q4
2012q1
Nominal GDP ($B)
14,253.2
14,273.9
14,415.5
14,395.1
14,081.7
13,893.7
13,854.1
13,920.5
14,087.4
14,277.9
14,467.8
14,605.5
14,755.0
14,867.8
15,012.8
15,176.1
15,319.4
15,467.8
Source: US Department of Commerce: http://www.bea.gov/national/index.htm#gdp
Real GDP ($B)
13,326.0
13,266.8
13,310.5
13,186.9
12,883.5
12,663.2
12,641.3
12,694.5
12,813.5
12,937.7
13,058.5
13,139.6
13,216.1
13,227.9
13,271.8
13,331.6
13,429.0
13,491.4
5.1%
Unemployment Rate
Year Jan Feb Mar Apr May Jun
Jul Aug Sep Oct Nov Dec Annual
2005 5.3
5.4
5.2
5.2
5.1
5
5
4.9
5
5
5
4.9
5.1
2006 4.7
4.8
4.7
4.7
4.6
4.6
4.7
4.7
4.5
4.4
4.5
4.4
4.6
2007 4.6
4.5
4.4
4.5
4.4
4.6
4.7
4.6
4.7
4.7
4.7
5
4.6
2008
5
4.9
5.1
5
5.4
5.6
5.8
6.1
6.1
6.5
6.8
7.3
5.8
2009 7.8
8.3
8.7
8.9
9.4
9.5
9.5
9.6
9.8
10
9.9
9.9
9.3
2010 9.7
9.8
9.8
9.9
9.6
9.4
9.5
9.6
9.5
9.5
9.8
9.4
9.6
2011 9.1
9
8.9
9
9
9.1
9.1
9.1
9
8.9
8.7
8.5
8.9
2012 8.3
8.3
8.2
8.1
8.2
8.2 8.3
8.1
7.8
Source: US Department of Labor: http://data.bls.gov/timeseries/LNS14000000
8.2
Unemployment Rates in the 1980s Recession
Year
1979
%
5.8
1980
7.1
1981
7.6
1982
9.7
1983
9.6
1984
7.5
1985
7.2
1986
7.0
Source: US Department of Labor: http://www.bls.gov/cps/prev_yrs.htm
Bank Failures Per Year
The average number of bank failures in the 1930s: 2000/year
2006
0
2007
2008
2009
2010
2011
2012
3
25
140
157
92
NA
Sources: FDIC:
http://www.fdic.gov/bank/historical/bank/2006/index.html
Q1: Was the downturn in 2008 the beginning of a
depression?
A: No!
Q2: Are we currently in a recession?
A: Technically, no!
However, the 2008-09 recession was one of the
most severe recessions since the Great
Depression.
It was a “Great Recession”!
Q: How did the “Great Recession” of
2008-09 start?
What was the timeline?
Partial Timeline ( Federal Reserve Bank of St. Louis):
•
4th quarter of 2007: Downturn in GDP (according to
National Bureau of Economic Research, the recession
began in December of 2007)
•
January 2–21, 2008: stock market downturn
•
January 22: The FOMC votes to reduce its target for the
federal funds rate 75 basis points to 3.5 percent
•
January 24: The National Association of Realtors
announces that 2007 had the largest drop in existing
home sales in 25 years
•
March 10: Dow Jones Industrial Average at the lowest level
since October 2006.
•
March 24: The Federal Reserve Bank of New York announces
that it will provide term financing to facilitate JPMorgan Chase
acquisition of bankrupt Bear Stearns Companies Inc.
•
July 11: IndyMac Bancorp is placed into the receivership of the
FDIC.
•
July 13: The U.S. Treasury Department announces a temporary
increase in the credit lines of Fannie Mae and Freddie Mac.
•
July 17: Major banks and financial institutions that had invested
heavily in mortgage backed securities report losses of
approximately $435 billion.
•
September 7: The Federal Housing Finance Agency places
Fannie Mae and Freddie Mac in government conservatorship
•
September 15: Bank of America announces its intent to
purchase Merrill Lynch for $50 billion
•
September 15: Lehman Brothers Holdings Incorporated files
for Chapter 11 bankruptcy protection
•
September 16: The Federal Reserve Board authorizes the
Federal Reserve Bank of New York to lend up to $85 billion to
the American International Group (AIG)
•
October 3: President Bush signs the Emergency Economic
Stabilization Act, creating a $700 billion Troubled Assets
Relief Program (TARP) to purchase failing bank assets
Etc.
•
Note: Such sequences of events had appeared before.
For example:
• The “Rich Man’s Panic” of 1907
• The Great Depression of 1929-1939
Q: We know the timeline, but what caused the crisis?
Some common answers:
•
•
•
•
•
Mortgaged backed securities, particularly those associated
with subprime mortgages;
The housing market bubble, which was made worse by
predatory, risky and careless lending;
Exotic financial instruments or derivatives that were
allegedly devised by some wunderkind mathematician or
physicist on Wall Street, e.g., collateralized debt
obligation and credit default swaps;
The events of September 11, 2001, the subsequent US
invasion of Iraq and increase in oil prices;
Irrational exuberance in the stock market followed by a
bear market;
• The Federal Reserve’s repeated reduction in the
discount rate and fed funds rate in 2001-2003;
• The wrongheadedness of the chairman of the Federal
Reserve, Mr. Alan Greenspan, who found himself in a
“state of shocked disbelief ” to learn that “the selfinterest of lending institutions” might not “protect
shareholders’ equity”;
• Deregulation of the banking industry (doing away with
Glass-Steagall Act), particularly the Financial Services
Modernization Act of 1999 or Gramm-Leach-Bliley
Act;
• Fraud, corruption, high salaries of CEOs, self-serving
economists, etc. (see, for example, “Inside Job”).
My answer:
While each of these explanations, or a combination of them,
might have some merit, they are mostly after-the-fact
explanations (post hoc ergo propter hoc).
We don’t know what caused the economic crisis that
began in 2008 (a “perfect storm?”).
We still don’t know what caused the “Great Depression”!
To be explained under “Crisis in Economic Theory””
Q: Why don’t we know?
A: Because the existing schools of economic thought are
incapable of explaining such crisis.
This holds particularly for the “neoclassical school,” which
is dominant economic theory.
But it also holds for other schools, such as the Keynesian
school.
It even holds for the Marxian school.
To be explained under “Crisis in Economic Theory””
Crisis in Economic in Theory
What Caused the
Great Depression?
Some common answers:
1) The stock market crash in 1929,
2) The banking panics and monetary contraction,
3) The protectionist policies pursued by the US
government—such as the Smoot-Hawley Tariff,
4) The actions of the Federal Reserve, which allowed a
decline in the money supply partly to preserve the gold
standard.
See, for example, “Great Depression,” Christina D. Romer, December 20, 2003:
http://elsa.berkeley.edu/~cromer/great_depression.pdf
All such explanations are, of course, ad
hoc.
To this day there is no consensus among
economists as to what caused the severe
depression that lasted from 1929 to 1939.
“Neither contemporary forecasters nor
modern times-series analysts could have
forecast the large declines in output following
the Crash [of 1929].”
(Kathryn M. Dominguez, Ray C. Fair and Matthew D.
Shapiro, “Forecasting the Depression: Harvard versus
Yale,” The American Economic Review, Vol. 78, No. 4
(September, 1988), pp. 595-612.)
The best economic “brains” of the 1920s, the socalled experts, could neither foresee the coming
disaster nor predict correctly its magnitude and
duration.
The comments of some of the
“experts” right before and after the
stock market crash of October 24, 1929
See, The Experts Speak: The Definitive Compendium of Authoritative
Misinformation, Christopher Cerf and Victor Navasky, 1984
The well-known neoclassical economist and monetary
“expert,” Irving Fisher, makes the following predictions
about the stock market:
October 17, 1929 (7 days before the crash): “Stocks
have reached what looks like a permanently high
plateau.”
November 14, 1929: “The end of the decline in the
stock market will... probably not be long.”
A year after the crash: “For the future, at least, the
outlook is bright.”
Other financial experts had similar outlooks and predictions
For example, the presidential advisor Bernard Baruch writes
on
November 15, 1929: “Financial storm has
definitely passed.”
Chairman of the Continental Illinois Bank of Chicago writes
on
October 24, 1929: “The crash is not going to have
much effect on business.”
The World Almanac of 1929 writes:
“The Market is following natural laws of economics and there
is no reason why both prosperity and the market should not
continue for years at this high level or even higher.”
Why the existing schools of economic
thought are incapable of explaining
crises?
The Neoclassical or Marginalist School
• This is the dominant school of economic theory
• It is a-historical theory that starts not with analyzing
any real economy, but with certain concepts in
mathematical physics.
• A “market” consists of two lines!
A “Market”
p (price per unit)
Supply
pe
Demand
Qe
Quantity
• All market are “self-adjusting”
• Left alone, they correct themselves and reach
equilibrium
• Laissez faire is the name of the game.
• This holds for the “labor market” and “capital
market”
Labor market
W (real wage)
Supply of labor
we
Demand for labor
Le
Quantity of
labor
Capital market
i (real interest)
Supply of capital
ie
Demand for capital
Ke
Quantity of
capital
In the neoclassical world:
• Neither fiscal policy nor monetary policy can change
the “real variables.”
• Deficit spending results in higher nominal interest
rates.
• Expansionary monetary policy results in higher prices.
There is actually no need for money in this world,
money is a “veil.”
The Keynesian School
Keynes clearly saw the incompatibility between the
neoclassical theories and the real world, particularly
during the Great Depression.
He criticized certain laissez faire aspects of these theories
and ultimately advocated for fiscal and monetary policies.
Yet, Keynes was educated in the same neoclassical school
and his criticism of these theories was halfhearted .
A few critical notes at the beginning of The General Theory
of Employment, Interest and Money (1936) were followed
by some theories that were incomplete, underdeveloped and
ambiguous.
The result was the “neoclassical synthesis,” a combination
of the old-fashioned neoclassical theories, called
microeconomics, and Keynesian theories, called
macroeconomics.
The ambiguities left in the General Theory has also allowed
for various kinds of “Keynesians.”
The Keynesians are at odds with one another as to how
high the deficit can go or what steps the Federal Reserve
System should take.
They disagree over such matters as how much regulation
the financial sector of the economy needs.
Yet, all Keynesians, similar to Keynes, believe in saving
capitalism from itself; reform, and not revolution, is their
aim.
The Marxian School
The Marxist economists believe in revolution and not
just reform.
For these economists a little more or a little less deficit
spending, or tinkering with the money supply, will not
solve the long-term problems of capitalism.
Financial woes of the capitalist economy cannot be
solved by more regulation.
Marxian economics, following Marx, does indeed
have crises theories.
In his Capital Marx had two theories of crisis, one
cyclical and another secular.
Neither of these theories, however, can explain the
Great Recession of 2008.
In sum, none of the prevailing economic theories
provide a viable option for understanding and
dealing with the Great Recession.
That is why I am waiting for new ways of thinking
and new economic theories!