Post on 06-Mar-2018
Teaching the Current Economic Crisis in
Introductory Economics Clark Ross
Davidson College Davidson, NC
Gabriel Sanchez Bonita High School
La Verne, CA
The presenters gratefully acknowledge the assistance of Asst. Professor Shyam Gouri Suresh (Department of Economics) and David Heilbron ’13, both from Davidson College.
Macroeconomics Content Areas
I. Measurement of Economic Performance – National income accounts – Unemployment
II. National Income and Price Determination – Aggregate demand – Macroeconomic equilibrium
III. Financial Sector – Money, banking, and financial markets – Loanable funds market – Central bank and control of the money supply
Macroeconomics Content Areas
IV. Stabilization Policies – Fiscal and monetary policies
V. Open Economy: International Trade and Finance
– Imports, exports, and financial capital flows
Full Content Area Descriptions: AP Economics Course Description, pg. 26-‐27, http://apcentral.collegeboard.com/apc/public/repository/ap-‐economics-‐course-‐description.pdf
Purpose of the Session
• Incorporate the Economic Performance of the US from 2005-‐2012 into an introductory economics course: – College level, AP, IB, or honors
• Do this by: 1. Explaining the crisis of 2007-‐2012. 2. Showing the policy tools that were used to
address the crisis. 3. Discussing the continued economics problems
and stagnation.
SETTING THE STAGE
Causes of the Crisis and Collapse (2004-‐2007)
High Aggregate Demand Fueled by: – High Consumer spending and low consumer savings
– Ease of home equity loans and credit borrowing – Stock market gains that increased real wealth and spending
– Expansion of residential real estate construction
Expansion of Residential Real Estate Construction
1. Low interest rates from expansionary monetary policy
2. Housing policy aimed at increasing home ownership
3. Incentive to negotiate new mortgages with high up-‐front costs
4. Variable-‐rate interest mortgages with low initial rates
Expansion of Residential Real Estate Construction
5. Legislation – Deductible mortgage interest and real-‐estate taxes – Financial Services Modernization Act of 1999 – Commodity Futures Modernization Act of 2000
6. Securitization of these mortgages, with their being sold to other financial institutions
7. Role of rating agencies – Standard and Poor’s – Moody’s
Price Level
Y
SAS
AD
AD’ LRAS LRAS’
Y0 2004
Y1 2007
Real GDP
Unemployment Rate
Consumer Price Index
Dow Jones
30 Year Real Mortgage Rate
1.00
2.00
3.00
4.00
5.00
6.00
7.00
%
REMEDIES IN 2007-‐2008
Traditional Tools of Expansionary Monetary Policy
1. Open Market Purchase of Bonds by Federal Reserve
2. Lower Discount Rate – Rate at which banks may borrow from the
Federal Reserve
3. Lower Required Reserve Ratio
Federal Funds Rate
2007-‐08 Fiscal Policy
• 2008: $152 Billion in Stimulus –Includes $600 credit to each taxpayer
• Fed Budget Deficit –1.2% of GDP in 2007 –3.2% of GDP in 2008
FURTHER REMEDIES IN
2009-‐2010
• Increasing problems signal need for more action –Unemployment rate was a major signal January 1, 2008 5.0 %
January 1, 2009 7.8%
January 1, 2010 9.7%
2009 Fiscal Policy
• American Recovery and Reinvestment Act –$787 Billion –Keynesian basis was assumed • Debate revolved around how big • Debate relating to proportion of Expenditure Increases versus Tax Decreases • Little Classical rebuttal
– Totaled almost 5% of GDP
2009 Fiscal Policy
• Troubled Asset Relief Program (TARP) – Actually passed under Bush in late 2008 • Result of the Emergency Economic Stabilization Act of 2008
– Truly implemented in 2009 – Slated for cost of $700 Billion • Only spent about half • Cost only $25 Billion according to the CBO
– Overseen by the Treasury Department – Purchased troubled bank assets
“March Oversight Report: The Final Report of the Congressional Oversight Panel,” 16 March 2011, http://cybercemetery.unt.edu/archive/cop/20110401232213/http:/cop.senate.gov/documents/cop-‐031611-‐report.pdf
State/Local Gov’t Expenditure as Percentage of GDP
• Formula/Definition: – Yield on a 10 year government bond, adjusted for future inflation.
• Indicates negative real interest rates
10-‐Year Treasury Inflation-‐Indexed Security, Constant Maturity
10-‐Year Treasury Inflation-‐Indexed Security, Constant Maturity
Loanable Funds Market
• In current crisis there is no Crowding Out • Given the very elastic supply of funds to purchase government bonds –Both purchases by the Federal Reserve (expanding balance sheet) and by foreign governments
$ Funds
rr
No Crowding Out
D D1
r0, r1
S
F0 F1
$ Funds
rr
Significant Crowding Out
D D1
r0
S
r1
F0 F1 F1’
F0 – F1’ = Amount of Crowding Out
With a less elastic supply of funds
2009-‐10 Monetary Policy
• Continuation of near-‐zero Fed Funds Rate • Quantitative Easing –Done by the FED –Overall strategy was the purchase of various financial assets with newly created money.
“QE 1 vs. 2 vs. 3…: A Framework for Analyzing Large Scale Asset Purchases as a Monetary Policy Tool,” Mark Gertler and Peter Karadi, March 2012, pg 2.
2009-‐10 Monetary Policy
• Quantitative Easing – QE 1 (Sept 2008): “the purchase over time of a variety of high grade securities, including agency mortgage backed securities (AMBS), agency debt, and long term government bonds, with AMBS ultimately accounting for the bulk of the purchases.”
– QE 2 (Oct 2010): “this time restricted to long term government bonds and smaller in scale than QE1.”
“QE 1 vs. 2 vs. 3…: A Framework for Analyzing Large Scale Asset Purchases as a Monetary Policy Tool,” Mark Gertler and Peter Karadi, March 2012, pg 2.
2009-‐10 Monetary Policy
• Quantitative Easing –QE 3 • Launched September 13, 2012 • FED will purchase $40 Billion of bonds per month • Open ended time frame • Expected to keep interest rates low “at least through mid-‐2015” • In addition to continued Operation Twist
“Fed to Launch QE3 of $40 Billion MBS Each Month,” Steve Goldstein, http://www.foxbusiness.com/markets/2012/09/13/fed-‐to-‐launch-‐qe3-‐40-‐billion-‐mbs-‐each-‐month/
2009-‐10 Monetary Policy
• Operation Twist – September 2011 – “essentially a sterilized acquisition of long term government bonds financed by selling some of its short term bonds.” –Aim was to encourage long-‐term investment by lowering long-‐term interest rates
“QE 1 vs. 2 vs. 3…: A Framework for Analyzing Large Scale Asset Purchases as a Monetary Policy Tool,” Mark Gertler and Peter Karadi, March 2012, pg 2.
FED Balance Sheet, 2007 Balance Sheet of Federal Reserve Banks, Feb 2007 (billions of dollars)
Assets Liabilities U.S. Government Securities 780.8 Federal Reserves
notes 770.9
Loans to Banks 0.2 Bank reserve deposits 22.9
Other assets 100.3 Other liabilities and capital 87.5
Total Assets 881.3 Total liabilities and capital 881.3
Macroeconomics: Theories and Policies, Richard T. Froyen, 10th Edition, pg. 304
Balance Sheet of Federal Reserve Banks, Feb 2011 (billions of dollars)
Assets Liabilities U.S. Government Securities 1201.4 Federal Reserves
notes 995.4
Loans to financial institutions 21.9 Bank reserve
deposits 1265.9
Mortgage-‐Backed securities 958.4 Other liabilities and
capital 244.1
Federal agency securities 144.2
Other assets 179.5
Total Assets 2505.4 Total liabilities and capital 2505.4
Macroeconomics: Theories and Policies, Richard T. Froyen, 10th Edition, pg. 307
FED Balance Sheet, 2011
Money Supply and GDP
• Velocity: The number of times per year that the average dollar in the money supply is spent for final goods and services. [Economics, McConnell Brue Flynn, 19th edition, 8-‐30]
M1V = PQ M1 x Velocity = Nominal GDP
Velocity of M1
MODEL CONSIDERATIONS / SUMMING UP
• Long term: the model works • Historical examples of looking back and seeing that the model was actually correct • 2007:“Perfect Storm” –Bubbles bursting –Greed –Decreased role of regulation
• 1932 and 2007 Financial Recessions with long recovery periods
FURTHER CONSIDERATIONS AND
RELATED CONCERNS
• Natural Rate of Unemployment • Savings •Wealth of Households • Europe • China
UNP
Natural Rate of UNP
• Natural Rate of Unemployment • Savings •Wealth of Households • Europe • China
Personal Savings
Personal Savings Rate
• Natural Rate of Unemployment • Savings •Wealth of Households • Europe • China
Total Net Worth
Median Value of Net Worth for Families
“US News: Families’ Net Worth Drops to ‘90s Level,” Kristina Peterson, The Wall Street Journal, 12 June 2012, A5.
Median Value of Net Worth for Families
“US News: Families’ Net Worth Drops to ‘90s Level,” Kristina Peterson, The Wall Street Journal, 12 June 2012, A5.
• Natural Rate of Unemployment • Savings •Wealth of Households • Europe • China
Trade Balance-‐EU
“Trade in Goods with European Union,” United States Census Bureau, http://www.census.gov/foreign-‐trade/balance/c0003.html
European Long-‐Term Interest Rates
“Long-‐term interest rate statistics for EU Member States,” European Central Bank, http://www.ecb.int/stats/money/long/html/index.en.html
• Natural Rate of Unemployment • Savings •Wealth of Households • Europe • China
Trade Balance-‐China
“Trade in Goods with China,” United States Census Bureau, http://www.census.gov/foreign-‐trade/balance/c5700.html
QUESTIONS / ANSWERS
Free Response 2009 Form B
2009 Form B Answer
2009 Form B Answer
2009 Form B Answer
Free Response 2010 Form B
2010 Form B Answer
2010 Form B Answer
2010 Form B Answer
Free Response 2011 Form B
2011 Form B Answer
2011 Form B Answer
2011 Form B Answer
Free Response 2011
2011 Free Response Answer
2011 Free Response Answer
2011 Free Response Answer
Free Response 2012
2012 Free Response Answer
2012 Free Response Answer
2012 Free Response Answer
c) 4 points: • 1 point is earned for stating that the current account
deficit will increase. • 1 point is earned for explaining that the increase in
real GDP increases income which causes imports to increase and net exports to decrease.
• 1 point is earned for stating that the international value of the bera will decrease.
• 1 point is earned for explaining that the decline in the international value of the bera is due to an increase in the supply of the bera.
Free Response 2008
2008 Free Response Answer
2008 Free Response Answer
2008 Free Response Answer
Free Response 2008 Form B
2008 Form B Answer
2008 Form B Answer
2008 Form B Answer
All data and graphs taken from:
Fed FRED http://research.stlouisfed.org/fred2/
Unless otherwise cited