Transcript 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
Monday, March 28, 2016
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
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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:
Monday, March 28, 2016
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
Price/10 Year Avg. Earnings
Source: http://www.econ.yale.edu/~shiller/data.htm
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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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“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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www.economist.com/finance/displaystory.cfm?story_id=12480887
www.nytimes.com/2008/10/03/business/03sec.html
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11
Availability of Bank Loans
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Currency & Reserves Up 4x
Oct. 17, 2012
Monday, March 28, 2016
http://research.stlouisfed.org/fred2/series/BASE
13
But Bank Reserves up 100x
Oct. 17, 2012
Monday, March 28, 2016
http://research.stlouisfed.org/fred2/series/WRESBAL
14
M0 = Currency + Bank Reserves ≈ $2.6t
Oct. 17, 2012
Monday, March 28, 2016
http://research.stlouisfed.org/fred2/series/BASE
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M1 ≈ $2.4t = Currency + Bank Deposits
Oct. 17, 20112
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http://research.stlouisfed.org/fred2/series/M1
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Money Mult. = M1/M0 ≈ 2.4/2.6 = 0.92
Oct. 17, 2012
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http://research.stlouisfed.org/fred2/series/MULT
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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
So M1/M0 < 1 =>
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l<0
18
Limits of Fed Magic
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New Yorker, Oct. 2008
19
The Zero Bound
Oct. 17, 2012
Monday, March 28, 2016
http://research.stlouisfed.org/fred2/series/TB3MS
20
The Zero Bound (2)
Oct. 17, 2012
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http://research.stlouisfed.org/fred2/series/FEDFUNDS
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The Zero Bound (3)
T.I.P.S.
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22
Quantity of Money Equation
M*V ≡ P*Y
Money * Velocity ≡ Price * Output =>
ln(M) + ln(V) = ln(P) + ln(Y) =>
i.e.,
%∆M
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+ %∆V = %∆P + %∆Y over time
23
%∆ Money Turnover [ = %∆ (Money x Velocity) ]
is Too Pro-Cyclical because of Velocity
% ∆ (M x V)
% ∆M
%∆V
28-Mar-16
24
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
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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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26
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
Monday, March 28, 2016
27
Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
interest
rate
FISCAL Expansion:
Money Demand = Supply
GDP
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28
Keynesian Multiplier: Evidence
Source: IMF World Economic Outlook and IMF Fiscal Monitor, Oct. 2012
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Another Illustration: Multiplier > 1
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30
NY Times, Oct. 23, 2012
Okun’s Law (1): Unemployment Gap
Oct. 24, 2012
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Okun’s Law (2): Output Gap
Oct. 24, 2012
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Okun’s Law (3)
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Okun’s Law (4)
Oct. 17, 2012
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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) 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
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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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Why it Matters to Everyone
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Worst Long-Term Unemployment
Oct. 17, 2012
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http://research.stlouisfed.org/fred2/series/UEMPMEAN
39
Long Unemployment Dip
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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.
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41
International Housing Prices
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42
Sun Belt, Rust Belt Concentration
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43
2006 Peak of Price-to-Rent
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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.
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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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Long Term Fiscal Gap: Unsustainable
http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
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Sure as Debt and Taxes
http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
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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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The Zero Bound (3)
T.I.P.S.
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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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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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54
Inflation/Devaluation Appears
a “Painless” Way Out of Debt
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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.
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