TeachingtheCurrent) Economic)Crisisin) IntroductoryEconomics ) Department/Econom… ·...

$: TeachingtheCurrent) Economic)Crisisin) IntroductoryEconomics ) Department/Econom… · TeachingtheCurrent) Economic)Crisisin) IntroductoryEconomics ) ... MORTG-\r1 year inflation$
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

Presenter

Origins Economic problems of 06, 07

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

%

Presenter

MORTG- 1 year inflation rates (avg. of CPI and PGD) http://www.phil.frb.org/research-and-data/real-time-center/survey-of-professional-forecasters/historical-data/inflation-forecasts.cfm

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

Presenter

Spending Multiplier not having a real impact Drop off right after the end of recession period

• 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.

Presenter

http://www.federalreserve.gov/newsevents/conferences/GertlerKaradi.pdf


• 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.”



• 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/


• 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


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

Personal Savings

Personal Savings Rate

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.

Presenter

http://ezproxy.lib.davidson.edu/login?url=http://search.proquest.com/docview/1019869253?accountid=10427

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.

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

Presenter

http://www.ecb.int/stats/money/long/html/index.en.html

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

2010 Form B Answer

2011 Form B Answer

Free Response 2011

2011 Free Response Answer

Free Response 2012


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 Form B Answer

All data and graphs taken from:

Fed FRED http://research.stlouisfed.org/fred2/

Unless otherwise cited

http://research.stlouisfed.org/fred2/

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