Presentation Transcript

1. Business, Government, and the World Economy

   Introduction
2. Economic Quiz What is the current unemployment rate? How many people are currently unemployed? What is the size of US nominal GDP? What was the rate of growth of US GDP in 2nd quarter? What is the yield on 10 year Treasury Bonds? What is the amount of debt owed by US as a % of GDP?
3. Economics What is Economics? The study of the allocation of scarce resources
4. Macroeconomics Interrelationship of Aggregate Economic Variables Output (Gross Domestic Product) Productivity The level of prices (Inflation) Interest rates Employment (& Unemployment) Value of currency (Foreign Exchange)
5. Macroeconomic Goals Providing Jobs Economic Growth Increasing Productivity Increasing Standard of Living Stable Prices Others?
6. Basic Assumptions Markets work in the long-run “Equilibrium” prices and quantities can be achieved. Short-run constraints can inhibit long-run equilibrium Speed of Market Adjustment Government Policy Exogenous Shocks
7. Government Policy Monetary Policy Controlled by Federal Reserve Board Fiscal Policy Federal and State Taxes, Government Spending etc. Trade Policy Tariffs, quotas, etc. Regulatory Policy Environmental, occupational safety, equal opportunity laws, minimum wage etc..
8. Microeconomics vs. Macroeconomics Microeconomics - economic decisions faced by individual firms and individual consumers. Microeconomic decisions are based upon macroeconomic data as are macroeconomic policy decisions. There are the same underlying variables impacting both types of decision making – there has to be a link.
9. Common Questions Microeconomics Macroeconomics How much R&D will a firm undertake What is the level of interest rates? How can productivity be increased? How many I-Pods should Apple produce? How much leisure time do individuals desire? How can Output (GDP) be increased? Will consumers save or spend? How much will the country save in aggregate? What is the current price level? What is the current level of Unemployment?
10. Aggregating Micro? Macroeconomics is not simply the aggregation of individual results Fallacy of composition - not every individual acts the same way and even if they did the aggregate result may not reflect the individual result. For example, increasing nominal level of wages in an attempt to increase income…
11. Factors impacting the link between micro and macro Rigidities – Macroeconomic relationships are often slower to respond to changes than individual markets Liquidity – Short run decisions may not be based on long run expectations Knowledge – Information is asymmetric Expectations - Assumed relationships may be impacted by expected changes, as opposed to current events.
12. Positive vs. NormativeEconomics Positive – What does occur under a given set of conditions – As prices rise demand falls. Normative – what should occur – includes judgment – how should income be distributed?
13. Basic Economic Assumptions Laws of Supply and Demand Utility Maximization Markets Forces Work in the Long Run
14. Ceterius Paribus“Other things being equal” Multiple economic variables often change at any given time. Most economic models keep the variables not under consideration constant. Therefore looking at only the relationship between two variables will often produce inaccurate analysis.
15. Economic Theory Changes Economic theory can change over time – even theory that is supported by empirical evidence Example: The Phillips Curve
16. 1960’s Philips Curve
17. Monetary Policy 1960’s Focus on money market conditions. Use of Free reserves as indicator resulting in procyclical monetary policy.
18. 1970’s Phillips Curve ?
19. 1996-2005 Phillips Curve?
20. The Phillips Curve Has been modified to look at expectations of inflation as opposed to the level of inflation Tradeoff between inflation and unemployment is still a common discussion / stylized fact in the media and economic debates.
21. Measuring Economic OutputThe Key Variable: GDP Gross Domestic Product The market value of all final goods and services produced in a country during a given time frame.
22. Components of GDPY = C + I + G + NX Personal Consumption Expenditure (C) Items purchased by consumers Gross Private Domestic Investment (I) Spending by business, construction, and inventory investment Government Purchases (G) Total federal state and local government purchases Net Exports (F or NX) Exports minus Imports
23. Personal Consumption Expenditures Approximately 72% of GDP* www.bea.gov 1st qtr2011
24. Gross Private Domestic Investment Approximately 12% of GDP: Fixed Investment Nonresidential (Structures and Equipment) Residential Inventories GDP should account for everything produced Change in inventories, is an important number to watch (not the level).
25. Government Spending and Net Exports Government Spending: About 18% of GDP Federal - 7%: Defense vs. Non defense State and Local 11% Net Exports (Exports - Imports) Exports 11.6% Imports 14.3%.
26. Trends in GDP Components
27. Current Values1st Quarter 2010 Gross Domestic Product $14,597.7 Billion Real Gross Domestic Product $13,216.5 Billion Percentage change from previous quarter (annual rate) 2010 Qtr 2 2.4% 2010 Qtr 1 3.7% 2009 Qtr 1 5%
28. Contributors to GDP1st qtr 2010 Positive Consumption 1.15% Business Investment 3.14% Negative Net Exports -2.78%
29. Three Markets Good Markets Consumption, Business Investment, and Saving. Asset Market Financial Assets Money Labor Market Level of Employment and Wages
30. General Equilibrium Adjustment of Interest Rates and Prices result in the Simultaneous Equilibrium of the Goods, Asset, and Labor Markets (general equilibrium). Interest rates and prices impact the amount of Government Purchases and Net Exports as well (and they also influence the equilibrium in each market) Therefore changes in any of the three markets can impact the level of GDP and the components of GDP.
31. Macro Interactions Goods Market Consumption, Saving, and Investment Interest Rates & Prices GDP C+I+G+NX Government Purchases Asset Market Labor Market Wages and Employment Net Exports / Interaction with Global Economy
32. Outline of the Class Introduction (current state of the economy and the language of economics) Useful Mathematical Tools Labor, Goods, and Asset Markets General Equilibrium (combining the three markets into one model of the economy) Applying and using the model to understand the economic environment and make better business decisions.
33. Goals of the Class Students should improve their understanding of: Basic theoretical macroeconomic models and the issues surrounding their usefulness. How macroeconomic performance is measured by commonly used economic indicators. How changes in macroeconomic performance relates to the theoretical models and therefore impacts decision making in the business world.
34. Some Basic Economic Language Annual Rates Rates of Change Business Cycles Consensus Survey Moving Average Nominal vs. Real Dollars Revisions and Benchmarks Seasonal Adjustments
35. Economic Indicators Leading Indicators that move ahead of the total economy (ahead of GDP). Coincident Indicators that move with the level of GDP. Lagging Indicators that move following GDP.
36. Capacity Utilization vs. GDP1967-2007
37. The Current State of the Economy The lingering effect of the financial crisis Causes of the crisis The Great Recession Current conditions - slowdown or double dip? European Debt US deficit debate US housing market
38. The Big Picture Problems in Mortgage Market Global Credit Crisis / Bank failures / Equity Losses Declining Consumer Spending Decreased Business Investment
39. Who’s to Blame?
40. Products Underwriting Policy Markets How Financial Markets Enabled“Keeping up with the Joneses” New Products Poor Underwriting Public Policies Unintended Consequences Low Rates and International Capital Flows
41. Mortgage Market Developments Securitization and new participants Graham Leach Bliley Financial Modernization Act of 1999 Increased Use of Mortgage Brokers 2000 Commodity Futures Modernization Act Increased Access to Credit Subprime, Alt A, Option ARMs Products Underwriting Policy Markets
42. Securitization Products Underwriting Policy Markets Loan Bank A Loan Bank B Loan Bank Z Financial Intermediary Buys Loans, Forms a “Pool” and Issues MBS Insurance Firm, Banks, Pension Funds etc. Buy MBS – Cash Flows “Guaranteed” by Original Mortgages
43. Products Underwriting Policy Markets Average Size of Subprime Loans Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, over 50% to total subprime
44. Products Underwriting Policy Markets Credit Quality of Subprime Loans Originated each year Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, over 50% to total subprime
45. Products Underwriting Policy Markets Structure of Subprime Loans Originated each year Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, over 50% to total subprime
46. Products Underwriting Policy Markets Impact of Subprime Loans on Home Ownership "SubPrime Lending: A Net Drain on Homeownership," Center for Responsible Lending: March 2007
47. Products Underwriting Policy Markets Fannie Mae’sGuarantee of Alt A Loans NY Times October 4 "Pressured to Take More Risk Fannie Hit a Tipping Point"
48. Products Underwriting Policy Markets Blaming Fannie and Freddie? No - Fannie and Freddie were small relative to the entire market. Combined Subprime Purchases (% of Market)** Consumer demand created rapid prince increase Yes – Overall Size put them at risk for any Mortgage Market problem Securitizing more risky loans opened door for Private securitization Gramlich, E. "Subprime Loans: America's Latest Boom an Bust" 2007 ** "how HUD Mortgage Policy Fed the Crisis", Washington Post June 10, 2008
49. Products Underwriting Policy Markets International Capital Flows Consumer Spending On Exports Increased Foreign Holdings of $ Increased Inflow of Dollars Helps Keep Long Term Rates Low
50. Products Underwriting Policy Markets “The Perfect Storm” 2004 - 2007 Domestic and global institutions buy MBS in attempt to increase margins on “safe” securities, incorrectly rated. Institutions use higher debt levels for securitization. Underwriting standards deteriorate. Increased interest rate environment makes loans more likely to default Increasing Home Prices encourage consumers to overextend and speculate in housing market
51. Home Sales and Home Prices
52. Non Agency Mortgage Foreclosure Rates
53. Response of Consumers Increased access to credit and delusional optimism resulted in: Short-Term Speculative Focus Borrowing More and Saving Less
54. Case Study: Natalie Brandon 1985 Buys $105,000 house 30 Year fixed rate loan Payment = $770 2000-2006 Paid penalties to Refi 5 times in 5 years Yearly income = $100,000 2006 New Loan $625,500 2/28 7.99% teaser Payment = $4,585 Fall 2007 Home Value = $450,000 Attempt to Refi for 40 years at 6% Fails
55. Borrowing More & Saving Less
56. Equity Prices Compared to Past Recessions
57. Consumer Credit Outstanding Compared to Past Recessions
58. Impact of the Crisis Increase in Precautionary Saving Lost Wealth from Equity Declines High Unemployment Consumer Confidence hits Record Lows
59. Precautionary Saving If you were to lose your job, for how long could you afford to be out of work and still meet your financial obligations including monthly expenses? The 2009 MetLife Study of the American Dream
60. Confidence in Having Enough Money to Live Comfortably Throughout Retirement Years
61. “The Pressure I feel to buy more and better material possessions is greater than ever” Metlife Disagree Agree Gen 06 Y 09 Gen 06 X 09 Baby 06 Boom 09 Silent 06 09 All 06 09
62. Buyers Remorse Gen Y I regret making major purchases and wish I would have saved more over the past few years I have no regrets about the major purchases that I have made over the past few years Gen X Boomers Silents All
63. The Crystal Ball – The Big Picture How will Consumers Respond? Precautionary or Long Term Savings? Lost Faith in Investment Planning? View of home ownership Corporate Earnings Financial Markets and Regulation Regulatory Changes Long Term Inflation Fears Monetary and Fiscal Policy Interest Rates
64. The Current State of the Economy Slowdown or Double Dip? Federal Reserve Policy Fiscal Policy Global Headwinds
65. Some Troubling Signs Manufacturing Consumer Spending / Confidence Housing Unemployment
66. Employment: Non Farm Payrolls
67. Employment: Non Farm Payrolls
68. Consumer Credit Outstanding
69. Consumer Credit Outstanding