The Great Recession - Northwestern · PDF fileObjective •Discuss the Great Recession,...

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TheGreatRecession

LawrenceJ.ChristianoTransportationCenter, BusinessAdvisoryCouncil,May3-4,2017

Objective

• DiscusstheGreatRecession,2007-?

• Whatcausedit,whatmadeitlastsolong?• Whydidsofewpeopleseeitcoming?

• ImplicationsforWorldTradeandPolicy.

GreatRecession• Big,bypostWorldWarIIstandards.

The 2007-2009 Recession in PerspectiveOutput Consumption Investment Employment Hours

Percentage change, peak to trough2007-2009 Recession (2007 Q4-2009 Q3) -7.2 -5.4 -33.5 -6.7 -8.7Average Post WWII Recessions -4.4 -2.1 -17.8 -3.8 -3.2US Great Depression (1929 to 1933) -36 -23 -69 -27Christiano-Motto-Rostagno (2003)

SmallerthanGreatDepression.

Potentialoutput?

TotalProductionOverPopulation

GreatRecession:WhydiditHappen?• Initially,verypuzzling….scaryeven.

• Overbuildinginrealestateledtoimbalances:

• Unemployedconstructionworkerslookingforjobs.

• ‘plentyofjobs(e.g.,nursing),butunemployed(e.g.,constructionworkers)didn’thavetherightskills’

• Problem:unemploymentwashighacrossall sectors.

• Obamacare:

• FearthatACAwouldraisecostsofbusinessled`waitandsee’attitudeaboutfirminvestmentandnewhires.

• Problem:Surveysoffirmssuggestedthattheirmainproblemswere`lackofsales’.

So,WhatCausedit…whatwasthetrigger?

• CorrectioninHousingPricesinMid-2006.

• But,likeMrs.O’Leary’scowandChicagofire,didnothave tobringdownthehousingmarketandwholeeconomy.

• Whatturnedthehousingpricecorrectionintoadisaster:

• Housingpricecorrectionledtobankrun.

Trigger:housepricesstoppedrisinginMay2006

HousingPriceCorrectionNeedNotHaveLedtoHousePriceCollapseandCollapseinEconomy.

Whatturnedthehousingpricecorrectionintoadisaster?

• Housingpricecorrectionledtobankrun.

Thisiswhatabankrunlookedlikehistorically.

Thistime,bankrunswereinvisibletomostpeople(Gorton).

RunwasonShadowBankingSystemnot commercialbankingsystem.

ItwasnotgenerallyknownhowhugetheShadowBankingsystemwasandhowVulnerabletheShadowBankswere.

TheDramaoftheBankRunsBroughttoLifeinSomeGreatMovies!

Whydiditlastsolong?

• Ascredittohousingsectordriedup,housingpricesfellsharply.

• Fallinhousingpricesmadehomeownersfeelpoor,andcutbackspending.

• Firmsseeingfewersales,cutbackinvestment.

• Economyinatailspin.

• Perfectstorm:standardsolutiontorecessioncouldnotbeimplementedwheninterestrateshitzero.

• Abiginfrastructureprogrammighthavehelped.

Whatabouttrade?

EconomicactivityinUSandothercountriesremainsweak.

Investmentespeciallyweak,reducingTrade.

TradehassloweddownwithrelativeweaknessinUS,ChineseandotherEconomies.Also,WorldTradeOrganizationReportsthattraderestrictionsareontherise.

ImplicationsforPolicy

• Abankrunturnedwhatcouldhavebeenarelativelysmallhousingcorrectionintoamajordisaster.

• Theproblemwasnotsomuchinthecommercialbankingsystem.• Indeed,thecommercialbanksactedas`shockabsorbers’forthesystem.• ‘Toobigtofail’and’laxlendingstandards’inbanksnotthefirstorderofbusiness.

• Theproblemwastheshadowbankingsystem.• Itwasvulnerabletorunsbecauseithadnoprotectionfromacentralbank.• Mustbecarefultospotbank-likeinstitutionsandmakesuretheyarenotvulnerabletoruns.

BankingCrisis,the‘ThePanicof2007’(Gorton)

• Example ofaBank:• banktakesa$1depositandpromisestorepay$1inoneperiod.• Itlendsthemoneytoafirm,whichpromisestopaythe$1backintwoperiods(zerointerest!)• Maturitymismacth.

• Ifdepositorsatone bankwantmoneyback….• Bankcanrolloverliabilities• Bankcansellassetstoanotherbank.

• Ifdepositorsatallbankswantmoneyback…• Rollovercrisis.• Banksmustsellassetsoutsideindustrywhereassetsarenotwellunderstood.• Mustsellataloss(firesale).

RolloverCrisis:RoleofHousingMarket• Whatmattersistheactualvalueofassetsandtheirfiresale value.

• Ifbankissolventunder(firesale value),thenprobabilityofruniszero.

• RolloverCrisisHypothesis:• pre-2005,nocrisispossible,• post-2005crisispossible.

Pre-housing market correction Post-housing market correction

Assets Liabilities120 (105) Deposits: 100

Banker net worth 20 (5)

Banker net worth 10 (-5)