Memo to President Obama

May 14, 2010

TO: Barack Obama

FROM: Team 5 (Bryant, Cohen, Daly, Morra, Morrison, Sagar)

RE: Plan to increase GDP growth and lower unemployment

Dear Mr. President,

Today, the US is enjoying our third straight quarter of positive GDP growth (G), but unemployment (U) is still 9.7% (Exhibit A). Following the last two recessions, it took several quarters for U to decline, and Americans want it to improve ASAP. In this recession, we’ve experienced very sharp declines in 1) housing investment, 2) structure investment, and 3) consumer durables spending. Over the past year, we’ve seen signs of recovery in durables spending, but not in housing or structures (Ex. B-‐D). As a result, policy and stimulus efforts should focus on improving these segments of the economy to aid job growth, leading to growth in GDP (Ex. E).

Recommendations:

Domestic housing investment leads to job growth. Residential investment is a great show of optimism about the economy, which results in considerable growth in consumer spending and GDP. With the 46% drop in investment it’s easy to see why unemployment skyrocketed. Though we’ve spent nearly $1T buying toxic assets to spur private firms to increase lending, they haven’t done so. Therefore, we recommend increasing government spending financing home purchases (e.g. an expansion of the FHA loan program) for a wider segment of the population with a target of increasing investment by $250B this year. This would lead to a total investment of $600B (60% growth) and would create almost 3M jobs (Ex. B, F, G). As private lenders loosen lending requirements, we can then sell these mortgages back to the private sector.

Structural investment recovery after recessions is relatively slow (8-‐12 quarters) because companies need to be very confident in long-‐term growth opportunities before they begin investing in capacity (Ex. H). In addition, structural investment has been dragging down GDP for 6 quarters. Considering the dramatic drop in structural investment in this recession, we recommend tax incentives to improve structural investment by $100B this year. This incentive will ensure companies have the added capacity to meet rising demand. (Ex. I).

Consumer durables spending represents 8% of GDP and creates jobs to service demand. Durables have started to recover (Ex. D), and we recommend a stimulus plan to incent durable purchases (Ex. J).

To finance these programs, we recommend reducing defense spending. Defense does produce jobs and GDP growth, but when the budget is held constant, non-‐defense activities create more jobs than defense-‐related activities (Ex. K). We do not recommend raising taxes, which reduces the consumer spending we are trying to incent. In addition, financing through deficit spending does not seem politically feasible at this point in time.

Actions we do not recommend for this problem

1. Attempts to influence the S&P 500. There is a strong association between the stock market, GDP and payrolls, but stock prices are an indicator and not a driver of economic growth.

2. Efforts to control crude oil prices because they do not affect job creation. In fact, we found a doubling in crude oil prices leads to less than a 0.5% reduction in GDP growth (Ex. N).

3. We looked closely at the impact of tax cuts and found that they have little if any relationship with GDP and unemployment.

4. Purchasing toxic assets like mortgage-‐backed securities or homes doesn’t directly impact housing investments, won’t help G or U, and will actually worsen the housing crisis (Ex. O); becoming a landlord by buying 4 million houses may lead to inflation (Ex. P).

# # #

Team 5 Memo to President Barack Obama – Exhibits page 2

$0

$200

$400

$600

$800

$1,000

$1,200

1950 1960 1970 1980 1990 2000 2010

Spending on consum

er durables in $B (2005)

Durables spending is starting to recover

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

1950 1960 1970 1980 1990 2000 2010

Real residential investment $B (2005)

This is a housing recession

$0

$100

$200

$300

$400

$500

$600

1950 1960 1970 1980 1990 2000 2010

Real investment in structures $B (2005)

Structures are suffering

-‐10.0%

-‐7.5%

-‐5.0%

-‐2.5%

0.0%

2.5%

5.0%

7.5%

10.0%

-‐8% -‐4% 0% 4% 8%

Payroll growth

GDP growth

As PAYROLLS grow, so does GDP

Exhibits A-‐E: Current state and historical perspective of the economy

A: Today, unemployment is high but GDP growth is recovering

B: A sharp drop in residential investment led to this recession

C: Structural investment plunged during this

recession

D: Recent spending on consumer durables is

showing growth

E: Payroll growth leads to GDP growth

2%

4%

6%

8%

10%

12%

-‐15%

-‐10%

-‐5%

0%

5%

10%

15%

20%

1950 1960 1970 1980 1990 2000 2010

Unemployment rate Growth in GDP

Unemployment rate

Unemployment rate & GDP growth over time(recessions in gray, today's recovery in green)

Growth in GD

P


-‐4%

-‐2%

0%

2%

4%

-80% -40% 0% 40% 80%

Residential investment growth (%)

Employment growth (%

)

Residential investment leads to job growth

Exhibits F-‐G: Impact of residential investment growth on employment

F: 60% growth in residential investment improves employment by 2%.

G: A $250B increase in residential investment leads to over 3M jobs.

Exhibits H-‐I: The role of structural investment

H: Structural investment drags and lags.

-‐6,000

-‐4,000

-‐2,000

0

2,000

4,000

6,000

$-‐400 $-‐200 $0 $200 $400

Private Residential Investment growth $B (2005)

Employment growth (thousands)

Expected job growth from added residential investment

-‐3.0% -‐2.0% -‐1.0% 0.0% 1.0% 2.0%

% Con

tribu+

on to

GDP

Structures' % drag on GDP

65 70 75 80 85 90 95 100

1 2 3 4 5 6 7 8 9 10 11 12 13

Cummula+

ve Decrease in

Investmen

t following

recession

Structure investment lags recovery by 8-‐12 quarters

1981 Recession 1990 Recession 2001 Recession

`


-‐6,000

-‐4,000

-‐2,000

0

2,000

4,000

6,000

-‐200 0 200 400 600 800 1,000 1,200

Budgetary shift towards defense $B (2005)

Expected job grow

th (thousands)

When we shift the budget into defense, net job growth falls

I: Structural investment was hit harder in this recession than any time in last 50 years.

Exhibit J: Stimulus plans work in the short term, but choose program carefully

Though the economic success from “Cash for Clunkers” (CFC) is questionable, stimulating consumer spending is effective when executed properly. In CFC, GDP for Q32009 rose 2.2% (from a previous -‐.7%), and 1.45% was attributed directly to auto sales. U went down prior to the program as the industry geared up for future demand. Yet did CFC sales just borrow from future sales and later inhibit GDP? The data is inconclusive.

Consumers, dealers, manufacturers, and local governments certainly benefited, but CFC also had a negative domino effect on other industries and products. For instance, when “clunker” owners trade into new cars, those sales negatively impact any providers that support the clunkers. For example, used parts suppliers and mechanics will have just lost nearly 700,000 “patients” and gas stations will lose their best customers.

A stimulus plan that incents the purchase of durable goods such as cars has been effective in the past to spark growth and temporarily lower unemployment, though it’s important for all stakeholders to get as much benefit as possible, without negatively affecting any whose niche is weakened through its implementation. Therefore, incentive programs around unique, even monopolistic properties without many substitutes might be the best for programs like these in the future. For example, we suggest “Cash for Vacations,” a plan to get Americans to fill up the domestic skies by offering a 50% rebate on plane tickets purchased at traditionally off-‐peak times. There is no better domino effect on spending than getting people to travel, which is great for airlines, hotels, tourist attractions, rental car companies, taxi operators, babysitters, clothing companies and much more.

Exhibit K: Reducing defense spending reduction spurs job growth

$0

$100

$200

$300

$400

$500

$600

1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

Structural Investment ($B)

Structural Investment in the U.S. Recessions shaded in yellow

More defense spending


-‐20%

-‐15%

-‐10%

-‐5%

0%

5%

10%

15%

20%

-‐100% 0% 100% 200% 300% 400%

Annualized growth in crude oil price

Expected growth in GDP

A large jump in oil prices has little effect on GDP growth

Exhibits N-‐P: Actions we do not recommend and why

N: Since 1974, crude oil prices have had little impact on GDP growth (<0.5% when the price doubles).

O: Becoming a landlord by buying 4 million houses and renting them out to deserving Americans will further the housing crisis and further destabilize prices.

Buying underwater houses and then renting them out has several problems and almost no benefits. Given that only about 5.5 million existing homes were sold over the last 12 months (Nat’l Association of Realtors), the immediate effect of buying 4 million houses would be to inflate housing prices and to flood the market for rental properties with dangerous consequences. First, housing prices have finally begun to stabilize in both price and volume, if the administration buys up 4 million houses, there will be a demand shock to the system, pushing housing prices dramatically up, making them less affordable to “deserving Americans.” Secondly, flooding the market with new rental properties would sharply depress rental rates (current vacancy rates are alarmingly high). This sharp decline in rental rates would hurt the taxpayer who essentially is buying overvalued housing and then renting it out at depressed rental rates.

P: Buying toxic assets is a Bad Idea It is clear that the banking system is stalled and there is little liquidity in the credit markets. However, while the buying (or backing) of toxic assets may restore some liquidity to the credit markets, it is a poor economic choice. Home prices are finally stabilizing – this should lead to a reduction of the perceived risk of these “toxic” assets, aligning the value of these assets to their true level of risk. Once this alignment happens, several positive economic results are realized. Right now, the banks don’t want to sell the assets at spot market rates because they feel the market undervalues the assets and are therefore waiting for higher valuations. A stable (and reasonable) valuation of these assets allows both the banks and the market to feel confident in trading these assets, thus restoring liquidity. Secondly the Fed has injected a massive amount of money into the banking system, which has yet to pass these assets to the public through lending. As the housing prices slowly relax into a stable state, the assets will begin to flow in alignment with normalized pricing, creating an adiabatic expansion of the money supply, which will keep inflation low. With the immediate removal of toxic assets, the money supply may increase too quickly and lead to significant inflation.

Memo to President Obama

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