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James Stodder, (Ph.D., Economics, Yale 1990) Lally School of Management & Technology

Understanding the Financial Crisis Presentation to Students & Friends of Rensselaer Hartford Hartford, CT. James Stodder, (Ph.D., Economics, Yale 1990) Lally School of Management & Technology Rensselaer Polytechnic Institute at Hartford Hartford, Connecticut, USA. Outline of Talk.

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James Stodder, (Ph.D., Economics, Yale 1990) Lally School of Management & Technology

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  1. Understanding the Financial CrisisPresentation toStudents & Friends of Rensselaer HartfordHartford, CT James Stodder, (Ph.D., Economics, Yale 1990) Lally School of Management & Technology Rensselaer Polytechnic Instituteat Hartford Hartford, Connecticut, USA

  2. Outline of Talk • Keynes on Credit Cycles: - Why we need Regulation • Where is the Bottom? • Connecticut is “Middle of the Pack” • Government Deficit Spending • Needed in the Short-term • But a Big Problem Long-term

  3. (1) Biz & Credit Cycles J. M. Keynes: 1883-1946

  4. US Macro-Stability: Better, Room for Improvement 45% 55% 34% 66% Source: http://www.nber.org/cycles.html

  5. Bad News: Bubbles are Endemic Arlington Williams, “Price Bubbles” www.indiana.edu/~arlwilli/pdf%20files/bigmkts.pdf

  6. Good News: People Do Learn V. Smith & A. Williams, “Experimental Market Economics,” Scientific American, Dec. ‘92

  7. Price/10 Year Avg. Earnings Source: http://www.econ.yale.edu/~shiller/data.htm

  8. The Wisdom of Keynes “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, isruined in a conventional way,along with his fellows, so that no one can really blame him.” - J.M. Keynes (1931)

  9. “Paradox of Thrift” Keynes noted: Consumers cut back on their spending and save more during a recession. This only makes the recession worse. Similarly for Banks, Loan Loss Reserves (LLR)are often raised in a recession, justwhen households and businesses most need credit –ensuring more collapses and worsening the recession.

  10. Insurance => Moral Hazard =>Necessity of Regulation • Moral Hazard of Insurance: • If you had a car that is less damaged by any given car crash – would that make you drive faster? • If you (and everybody else) drove faster, could this actually wind up making you less safe ?

  11. www.economist.com/finance/displaystory.cfm?story_id=12480887 www.nytimes.com/2008/10/03/business/03sec.html

  12. Availability of Bank Loans

  13. Currency & Reserves Up 4x Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/BASE

  14. But Bank Reserves up 100x Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/WRESBAL

  15. M0 = Currency + Bank Reserves ≈ $2.6t Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/BASE

  16. M1 ≈ $2.4t = Currency + Bank Deposits Oct. 17, 20112 http://research.stlouisfed.org/fred2/series/M1

  17. Money Mult. = M1/M0 ≈ 2.4/2.6 = 0.92 Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/MULT

  18. Bank Money Multiplier If l= % loans, Reserve multiplier is D = R(1+l + l 2+… + l ∞ )=R/(1- l ) If M0 = Currency (C) + Reserves (R), M1=Currency + Deposits, so: M1 = C + R/(1- l ) = M0–R+ R/(1- l ) M1/M0 = 1+{-R + R/(1- l )}/M0 So M1/M0 < 1 => l < 0

  19. Limits of Fed Magic New Yorker, Oct. 2008

  20. The Zero Bound Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/TB3MS

  21. The Zero Bound (2) Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/FEDFUNDS

  22. The Zero Bound (3)T.I.P.S.

  23. Quantity of Money Equation M*V ≡ P*Y Money * Velocity ≡ Price * Output => ln(M) + ln(V) = ln(P) + ln(Y) => i.e., %∆M + %∆V = %∆P + %∆Y over time

  24. %∆ Money Turnover [ = %∆ (Money x Velocity) ] is Too Pro-Cyclical because of Velocity % ∆M • % ∆ (M x V) % ∆ V

  25. Keynes’s Liquidity Trap:

  26. Keynes’s Liquidity Trap:

  27. Keynes’s Liquidity Trap:

  28. Keynes’s Liquidity Trap:

  29. Keynesian Multiplier: Evidence Source: IMF World Economic Outlook and IMF Fiscal Monitor, Oct. 2012

  30. Another Illustration: Multiplier > 1 NY Times, Oct. 23, 2012

  31. Okun’s Law (1): Unemployment Gap Oct. 24, 2012

  32. Okun’s Law (2):Output Gap Oct. 24, 2012

  33. Okun’s Law (3)

  34. Okun’s Law (4) Oct. 17, 2012

  35. Output Gap ≈ 20% GDP http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08-Outlook_Testimony.pdf A little Stimulus Math: 20% * $14 tr. = $2.8 tr. Stim*1.5 = $2.8 => Stim = $1.87 tr.

  36. (2) Bottom Still a Ways Off Okun’s Law, and Slow Recovery Housing Recovery probably still a year away. Credit Markets still very weak. Stock Market Valuation Ratios like P/E and Tobin’s Q are now only at historical averages. Unemployment Trend: http://cr4re.com/charts/charts.html

  37. HousingBottom– A LongWayOff http://www.nytimes.com/imagepages/2008/10/16/business/16housing.graphix.ready.html

  38. Why it Matters to Everyone

  39. Worst Long-Term Unemployment Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/UEMPMEAN

  40. Long Unemployment Dip http://cr4re.com/charts/charts.html

  41. (3) CT & NY in “Middle of Pack” Financial Sector down, but .. Conventional Banking and Insurance less vulnerable than Investment Banks, Financial Insurance Defense industries well insulated Pharmaceuticals and Biotech have good long-term prospects House Price Increases near US Avg.

  42. International Housing Prices

  43. Sun Belt, Rust Belt Concentration

  44. 2006 Peak of Price-to-Rent

  45. Source: NY Times, April 20, 2010

  46. (4) More Federal Deficit Spending (not Tax Cuts) Necessary Tax cuts to the rich more likely to be saved, not spent or invested. Tax cuts don’t have big effect on those too poor to pay many taxes. Unmet needs in Energy, Environment, Health, and Education: good reasons to spend.

  47. Government Must Increase Spending in Severe Recession “ If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines … It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.” (Keynes, General Theory, 1937)

  48. But We Need Foreign Coordination for US Expansion to be Successful Benefits of lone expansion “leak out,” other countries free ride. Alternatives to joint expansion are protectionism and competitive devaluations. US long-term “Fiscal Gap” makes lone expansion untenable.

  49. Long Term Fiscal Gap: Unsustainable http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf

  50. Sure asDebt and Taxes http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf

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