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FROM ASSET BUBBLES TO A LIQUIDITY TRAP Presented by A.G. Malliaris

FROM ASSET BUBBLES TO A LIQUIDITY TRAP Presented by A.G. Malliaris A Conference on the Global Financial Crisis of 2007-09 April 11 , 2013. PURPOSE OF PRESENTATION. Consider the Cyclical Behavior of the U.S. Economy

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FROM ASSET BUBBLES TO A LIQUIDITY TRAP Presented by A.G. Malliaris

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  1. FROM ASSET BUBBLES TO A LIQUIDITY TRAP Presented by A.G. Malliaris A Conference on the Global Financial Crisis of 2007-09 April 11, 2013

  2. PURPOSE OF PRESENTATION • Consider the Cyclical Behavior of the U.S. Economy • Distinguish 4 Phases: Expansion, Upper Turning, Recession and Lower Turning • Focus on the Global Financial Crisis of 2007-09 • Introduce Behavioral Hypotheses

  3. “We can model the euphoria and the fear stages of the business cycle. Their parameters are quite different. We have never successfully modeled the transition from euphoria to fear” Alan Greenspan

  4. CHALLENGE • Decompose an economic cycle into 4 phases instead of just 2 • Introduce Upper Turning Period and Lower Turning Period

  5. Expansion Recession

  6. Upper Turning Period Recession Expansion Lower Turning Period

  7. METHODOLOGY • Use Current Economic Reasoning • Introduce Ideas from Behavioral Finance • Reconsider Keynes’s “Animal Spirits” • Employ Minsky’s Financial Instability Hypothesis • Apply This Methodology to the Latest Global Financial Crisis

  8. The Expansion Phase: December 2001 to November 2007 • The expansion was weaker than average • One major event: the formation of the Housing Bubble

  9. “The dogmas of the quiet past are inadequate to the stormy present” Abraham Lincoln

  10. Asset Price Bubbles • Interplay Between Economic and Behavioral Factors • Economic Factors: Easy Monetary Policy; Global Imbalances; Financial Innovations; Poor Incentives and Regulation • Behavioral Factors: Representative Heuristic, Feedback Mechanism, Overconfidence, Short Selling Constraints

  11. Upper Turning Period:January 2007 to September 2008 • Concave, Fragile and Ambivalent • Housing Prices Peak by Mid-2006 and then Begin to Decline • Behavioral Finance: Prospect Theory • From a Subprime Crisis to a Full Credit Crisis • Lehman’ s Bankruptcy • Financial and Psychological Amplification • Minsky’s Instability Hypothesis

  12. The Great Recession

  13. Job Losses Were Unprecedented

  14. The Lower Turning Period: The Liquidity Trap • When Interest Rates Are Close to Zero While the Economy is Below Its Potential and Has High Unemployment • Period of Economic and Psychological Uncertainty • Aggressive Monetary Policy: Q1, Q2, Q3 • Indecisive Fiscal Policy

  15. GDP Fell Far Below What the Economy Was Capable of Producing

  16. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die. Keynes 1936

  17. Legislative Response

  18. Financial Stability Oversight Council • Established by under the Dodd-Frank Wall Street Reform and Consumer Protection Act • Restore Optimism in Long-run Economic Expectations • Reconsider Price Stability, Financial Stability and Global Economic Stability • Reassess Debt-Financed Government Spending • Support Growth that Generates Employment

  19. “It is better to act and repent than not to act and regret it” Machiavelli

  20. THANK YOU

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