The Future of Our Economic Environment

Ryan Herzog, Ph.D. Assistant Professor of Economics

Gonzaga University 10/24/2009

Prepared for Fall Family Weekend

$787 billion

$700 billion

$1.4 trillion

777 ARRA

TARP

TALF

ARM

Negative Am

Housing Bubble

Subprime

Bear Stearns

Fannie Freddie

Lehman AIG

$168 Billion

Bailout Bankruptcy

Main Street

Wall Street

Contained

Nationalize MBS

CDOs

Credit Default Swaps

Depression

$12 trillion

Default

Foreclosure

Moral Hazard

Systemic Risk Quantitative Easing

Speculation

Flip Country Wide

Washington Mutual GM

Chrysler

Frozen

Going Forward

• We can’t change the past • Fiscal Policy

– Are we digging too large of a hole?

• Monetary Policy – Was it bad policy, bad regulations, or something

else?

• International Issues – What about our large external deficits?

Change in GDP (2007-2009)

2007-III 2007-IV 2008-I 2008-II 2008-III 2008-IV 2009-I 2009-II

Percent change in gross domestic product 3.6 2.1 -0.7 1.5 -2.7 -5.4 -6.4 -0.7

Personal consumption expenditures 1.35 0.86 -0.39 0.06 -2.49 -2.15 0.44 -0.62

Gross private domestic investment 0.14 -1.29 -1.2 -1.66 -1.04 -3.91 -8.98 -3.1

Net exports of goods and services 1.36 2.24 0.36 2.35 -0.1 0.45 2.64 1.65

Government spending 0.75 0.31 0.51 0.71 0.95 0.24 -0.52 1.33

Key Variable - Projections

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

CBO's Projection of Key Economic Variables

Real GDP (Percentage Change)

CPI (Percentage Change)

Unemployment Rate

Exploding Government Spending

0.0

500.0

1000.0

1500.0

2000.0

2500.0

3000.0

3500.0

4000.0

Jan-

90

Feb-

91

Mar

-92

Apr-

93

May

-94

Jun-

95

Jul-9

6

Aug-

97

Sep-

98

Oct

-99

Nov

-00

Dec-

01

Jan-

03

Feb-

04

Mar

-05

Apr-

06

May

-07

Jun-

08

Billi

ons

of D

olla

rs

Government Expenditure and Receipts

Federal Government Expenditures

Federal Government Receipts

Fiscal Debt - Projections

0

20

40

60

80

100

120

140

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

20,000,00019

4019

4419

4819

5219

5619

6019

6419

6819

7219

7619

8019

8419

8819

9219

9620

0020

0420

0820

1220

16

Mill

ions

of D

olla

rs

Gross Federal Debt (Millions ofDollars)

Gross Federal Debt (% GDP - rightscale)

Government Spending

0

1000

2000

3000

4000

5000

6000

Billi

ons

Current Expenditure

Transfer Payment

Interest Payments

Government – Interest Payments

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Mill

ions

Projected Interest Payments

Payments (4%)

Payments (5%)

Payments (6%)

Actual (through 2008)

Overview of Fiscal Policy

• Should we be concerned about added spending?

• Where will the money come from and at what cost?

• Is an 88% (of GDP) debt loan high? – Japan currently has a debt loan of 170%

• A new tax system that centers around a value added tax, a broad tax base with low tax rates, taxing consumption, and taxing bads.

TOP 10 REASONS TO STUDY ECONOMICS

1. Economists are armed and dangerous: "Watch out for our invisible hands.“ 2. Economists can supply it on demand. 3. You can talk about money without every having to make any. 4. You get to say "trickle down" with a straight face. 5. Mick Jagger and Arnold Schwarzenegger both studied economics and look

how they turned out. 6. When you are in the unemployment line, at least you will know why you are

there. 7. If you rearrange the letters in "ECONOMICS", you get "COMIC NOSE". 8. Although ethics teaches that virtue is its own reward, in economics we get

taught that reward is its own virtue. 9. When you get drunk, you can tell everyone that you are just researching the

law of diminishing marginal utility. 10. When you call 1-900-LUV-ECON and get Kandi Keynes, you will have

something to talk about.

Monetary Policy

• What is it? • Is the Federal Reserve to blame for the

housing bubble? • Should the Federal Reserve respond to

changes in asset prices? • Are we setting ourselves up for a period of

high inflation (is stagflation possible)

Policy Rules and Inflation Targeting

Was Policy too Loose?

Did Low Interest Rates Create the Bubble?

Short-term and Long-term Rates

Loanable Funds

Monetary Policy Today

0.000

200.000

400.000

600.000

800.000

1000.000

1200.000

1400.000

1600.000

1800.000

2000.000

Jan-

90

Dec-

90

Nov

-91

Oct

-92

Sep-

93

Aug-

94

Jul-9

5

Jun-

96

May

-97

Apr-

98

Mar

-99

Feb-

00

Jan-

01

Dec-

01

Nov

-02

Oct

-03

Sep-

04

Aug-

05

Jul-0

6

Jun-

07

May

-08

Apr-

09

Billi

ons

Federal Reserve – Select Liabilities

Monetary Base

M1

Excess Reserves

Currency

Monetary Policy Today

0.000

200.000

400.000

600.000

800.000

1000.000

1200.000

1400.000

1600.000

1800.000

Billi

ons

Federal Reserve - Select Assets

Total Borrowings

Securities Held Outright

Monetary Policy - Overview

• The Fed was unable to control long-term interest rates – Large inflows of foreign capital kept interest rates

extremely low • We have to be careful when we try to pop

bubbles – The early euphoria phase is well liked – Price setting does not work

• Will the Fed be able to unwind their balance sheet?

International Issues

• Prior to the crisis we were concerned over the growing external deficits. – What is happening today?

• Should we be worried about a declining dollar?

Current Account Imbalance

-250.000

-200.000

-150.000

-100.000

-50.000

0.000

50.000

Jan-

90

Dec-

90

Nov

-91

Oct

-92

Sep-

93

Aug-

94

Jul-9

5

Jun-

96

May

-97

Apr-

98

Mar

-99

Feb-

00

Jan-

01

Dec-

01

Nov

-02

Oct

-03

Sep-

04

Aug-

05

Jul-0

6

Jun-

07

May

-08

Apr-

09

Billi

ons o

f U.S

. Dol

lars

Current Account

Overview

• Prior to the crisis – The current account balance had many

economists predicting a hard landing, a complete loss of external financing.

• Post crisis – The depreciation of the dollar (thanks Fed) has

caused exports to decrease less than imports.

Concerns Going Forward

• Financing the Government Deficit – In 2001, $1 trillion was financed by foreigners

• $378 billion by Japan, $78 billion by China – In 2008, $3 trillion was financed by foreigners

• $727 billion by China, $626 by Japan

• Can the Fed wind down their balance sheet? – In 2007, they had $850 billion in liabilities – Today they have $2.1 trillion in liabilities

• How long will the flight to quality last? – Low interest rates and cheap financing!

Thank You

• Go DUCKS!

Misc. Graphs