Post on 23-Jan-2016
description
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Understanding the Great Recession
Using macro to understand the current recession
Let’s analyze the history of the recession to illustrate some of the major macro issues/tools
Underlying forces:1. Increasing leverage with lower perceived risks2. The housing bubble and …. not “pop” but “hissssssss”3. A “run on the banks” and the Lehman bankruptcy4. The crash in asset prices in 20085. Huge decline in wealth, leading to declining housing I and C.6. International transmissions7. IS-MP curve interpretation8. Liquidity trap!9. Governmental response in monetary and fiscal policies10.The trough in late 200911.The long stagnation is still with us ….
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3
The bubble economy
Trends in volatility of US stock prices
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Note: Implied volatility is a measure of the equity price variability implied by the market prices of call options on equity futures. Historical volatility is calculated as a rolling 100-day annualized standard deviation of equity price changes. Volatilities are expressed in percent rate of change. VIX is CBOE index.
Historical lows
Leveraging the US economy
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0
1
2
3
4
5
0
2
4
6
8
10
1930 1940 1950 1960 1970 1980 1990 2000 2010
Total financial assets/ KTotal financial assets/ GDP
Source: Federal Reserve flow of funds data.
Rising leverage of US economy
Leverage for US economy
6Gelain et al, San Francisco Fed Working Paper.
The result on housing prices
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1. Rising perceived wealth of households 1995-2006.
2. Then catastrophic loss of wealth 2006-2009
3. No recovery as of Nov 30, 2012.
80
100
120
140
160
180
200
220
86 88 90 92 94 96 98 00 02 04 06 08 10 12
Real Housing Prices (1995 = 100)
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Then people wake up from the dream to the nightmare of
falling wealth …
Mortgage delinquencies skyrocket
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10
-18,000
-16,000
-14,000
-12,000
-10,000
-8,000
-6,000
-4,000
-2,000
0
2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1
Loss of Household Wealth in Recession(billions of 2005$)
Housing
Net worth
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-18,000
-16,000
-14,000
-12,000
-10,000
-8,000
-6,000
-4,000
-2,000
0
2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1
Loss of Household Wealth in Recession(billions of 2005$)
Housing
Net worthWealth loss of
$16 trillion ($140,000 per household)
The impact on households and consumption
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-20,000
-16,000
-12,000
-8,000
-4,000
0
4,000
8,000
12,000
-300
-200
-100
0
100
200
300
400
500
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Change in new worthChange in consumption
Dot.combubble
Housing burstand financialmeltdown
Bank runs
Series of bank runs.Different from earlier (Depression era) because was
the run by large depositors (run on the repo).Bear Stearns and Lehman were wiped out in a week.
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Bank losses*
14* Note that US bank equity was around $1000 billion in 2010.
The Lehman Bankruptcy
A central event in the crisis.Market fundamantalists worried that continued bailouts
would lead to “moral hazard” and worse future problems.
So on September 15, 2010, government decided to let Lehman go bankrupt.
Catastrophic results:- markets froze up (people could not make transactions)- stock market went down 30 % in a month and US dollar ROSE almost 20 %.- market fundamentalism lasted just 36 hours (!)- then bailout of AIG, Citibank, BofA, TARP, GM, etc.
“An economy in free fall” in the fall of 2008.
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Risk on Mature Govt Debt (US, etc.)
16CDS = risk that security will default. These are US and similar Treasury bonds!
A risk measure on commercial paper
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Source: Federal Reserve page on commercial paper. These are short-term promissory note or unsecured money market obligation, issued by prime rated commercial firms and financial companies. This shows medium-grade (A2/P2) minus top grade (AA).
18IMF
Risk premiums on
top-rated securities
Policymakers respond
Bush/Paulson: reluctantly saw that financial markets were freezing up (Bernanke key to understanding this).
TARP: Started as buying toxic assets, then saw the light and recapitalized banks.
Panic of 2008: Financial markets hysterical; paranoia everywhere about who was responsible and who should pay.
One paranoid view: The tale of Chicken Little (coming up)
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Clueless policymaker in 2008
Fed projections, June 2008
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22= Fed forecasts = Range of all 19 participants
A disastrous forecast
Macroeconomic impacts
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Impact of Credit Crunch on Investment
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.10
.11
.12
.13
.14
.15
.16
.17
.18
5.5
6.0
6.5
7.0
7.5
8.0
8.5
9.0
9.5
2005 2006 2007 2008 2009 2010
Investment/ Potential GDPBaa bond rate
Creditcrisis
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0.84
0.88
0.92
0.96
1.00
1.04
1.08
1.12
2000 2002 2004 2006 2008 2010 2012
Actual/potential industrial production
Effect on output
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Lehman
Bear
Macroeconomic impacts
Rewrite augmented IS and MP curves as follows:
IS: Y = C(Y,W) +I(rb) + G + NX(Y,Yw)
Y = C(Y,W) +I(i - π + σ) + G + (X – M)
MP: i = f(Y, π)
rb = risky real rate = i - π + σ, where σ is the risk premium
Have adverse IS shifts to W, σ, and NX from Yw
Fed lowers i in standard manner, but real interest rate for businesses goes up!
MP = Taylor rule
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iff
Y
IS(i ff - π + low risk premium)
i*
MP
2006
Before crisis
iff
Y
IS(i ff - π + low risk premium)
i*
MP
2008
After financial crisis
IS’(i ff - π + high risk premium)
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Policy Responses (thanks to Keynes’s theories)
Gwendolen Darwin Raverat
Financial Market Support Measures 2007-2012
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Unconventional Fed Measures: the Fed Balance Sheet
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Treasuries = normal stuff!; CPLF = commercial paper funding facility; MBS = mortgage-backed securities
Fed balance sheet before and after the crisis
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iff
Y
i*
MP
2008
Before Fed expansion
IS’
iff
Y
i*
MP
2009
Fed expansion
IS’
iff
Y
i*
MP
2009
After TARP and other risk-reducing measures
2010
IS’’
Fiscal Policy in the Liquidity Trap:Components of US stimulus legislation
36Source: CBO, presentation of Elmendorf, June 2009
iff
Y
i*
MP
IS(2008)
Without stimulus
iff
Y
i*
MP
IS(2008) IS(2010)
With stimulus
CBO’s estimate of impact of stimulus on economy
39Source: CBO, presentation of Elmendorf, June 2009.
CBO’s estimate of impact of stimulus on economy
40Source: CBO, presentation of Elmendorf, June 2009.
Actual
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When will it ever end?