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Wednesday, April 19, 2023Wednesday, April 19, 2023 11

Understanding the Financial CrisisUnderstanding the Financial Crisis Presentation toPresentation to

Students & Friends of Rensselaer HartfordStudents & Friends of Rensselaer HartfordHartford, CTHartford, CT

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

Rensselaer Polytechnic Institute at HartfordHartford, Connecticut, USA

Outline of TalkOutline of Talk

1.1. Keynes on Credit Cycles: Keynes on Credit Cycles: - Why we need Regulation- Why we need Regulation

2.2. Where is the Bottom?Where is the Bottom?

3.3. Connecticut is “Middle of the Pack”Connecticut is “Middle of the Pack”

4.4. Government Deficit SpendingGovernment Deficit Spendinga.a. Needed in the Short-termNeeded in the Short-term

b.b. But a Big Problem Long-termBut a Big Problem Long-term


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



US Macro-Stability: US Macro-Stability: Better, Room for Improvement Better, Room for Improvement

Source: http://www.nber.org/cycles.html

45% 55%

66%34%

Bad News: Bubbles are Bad News: Bubbles are EndemicEndemic


Arlington Williams, “Price Bubbles”www.indiana.edu/~arlwilli/pdf%20files/bigmkts.pdf

Good News: People Do LearnGood News: People Do Learn


V. Smith & A. Williams, “Experimental Market Economics,” Scientific American, Dec. ‘92

Price/10 Year Avg. EarningsPrice/10 Year Avg. Earnings


Source: http://www.econ.yale.edu/~shiller/data.htm

The Wisdom of KeynesThe Wisdom of Keynes


““A sound banker, alas, is not one A sound banker, alas, is not one who foresees danger and avoids who foresees danger and avoids

it, but one who, when he is ruined, it, but one who, when he is ruined, isis ruined in a conventional way,ruined in a conventional way, along with his fellows,along with his fellows, so that no so that no one can really blame him.” one can really blame him.”

- J.M. Keynes (1931)- J.M. Keynes (1931)


“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, just when households and businesses most need credit –ensuring more collapses and worsening the recession.

Insurance => Moral Hazard =>Insurance => Moral Hazard =>Necessity of Necessity of RegulationRegulation


Moral HazardMoral Hazard of Insurance: of Insurance:

If you had a car that is less damaged If you had a car that is less damaged by any given car crash – would that by any given car crash – would that make you drive make you drive fasterfaster??

If you (and everybody else) drove If you (and everybody else) drove faster, could this actually wind up faster, could this actually wind up making you making you less safeless safe ? ?


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

Availability of Bank LoansAvailability of Bank Loans


Currency & Reserves Up Currency & Reserves Up 4x4x


Oct. 17, 2012

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

But Bank Reserves up But Bank Reserves up 100x100x


Oct. 17, 2012

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

M0 = Currency + Bank M0 = Currency + Bank ReservesReserves ≈ $2.6t ≈ $2.6t


Oct. 17, 2012

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

M1 ≈ $2.4t = Currency + Bank M1 ≈ $2.4t = Currency + Bank DepositsDeposits


Oct. 17, 20112

http://research.stlouisfed.org/fred2/series/M1

Money Mult. = M1/M0 ≈ 2.4Money Mult. = M1/M0 ≈ 2.4//2.6 = 0.92 2.6 = 0.92


Oct. 17, 2012

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

Bank Money MultiplierBank Money MultiplierIf If ll = % loans, Reserve multiplier is= % loans, Reserve multiplier is

D = R(1+D = R(1+ l + l l + l 22++… … + l + l ∞∞ ) )== R/(1- R/(1-

l l ))

If M0 = If M0 = Currency (C) Currency (C) + Reserves (R),+ Reserves (R),

M1=M1=CurrencyCurrency + + DepositsDeposits, so:, so:

M1 = M1 = C C + + R/(1- R/(1- l l ) ) = = M0–RM0–R+ + R/(1- R/(1- l l ))

M1/M0 = 1+{M1/M0 = 1+{-R -R + + R/(1- R/(1- l l )}/M0)}/M0

So So M1/M0 < 1 M1/M0 < 1 => => l l < 0 < 0 Wednesday, April 19, 2023Wednesday, April 19, 2023 1818

Wednesday, April 19, 2023Wednesday, April 19, 2023 1919New Yorker, Oct. 2008

Limits of Fed MagicLimits of Fed Magic

The Zero BoundThe Zero Bound


Oct. 17, 2012

http://research.stlouisfed.org/fred2/series/TB3MS

The Zero Bound (2)The Zero Bound (2)


Oct. 17, 2012

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

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


Quantity of Money EquationQuantity of Money Equation

M*V M*V ≡ ≡ P*YP*Y

MMoney * oney * VVelocity elocity ≡ ≡ PPrice * rice * OOutput =>utput =>

ln(M) + ln(V) = ln(P) + ln(Y) =>ln(M) + ln(V) = ln(P) + ln(Y) =>

i.e., i.e., %%∆∆M + M + %∆%∆V = V = %%∆∆P + P + %%∆∆Y over Y over timetime


Apr 19, 2023Apr 19, 2023 2424

%∆ Money Turnover [ %∆ Money Turnover [ = %∆ (= %∆ (MMoney x oney x VVelocity) elocity) ] ] is Too is Too ProPro-Cyclical because of -Cyclical because of VelocityVelocity

% ∆ (M x V)

% ∆ V

% ∆M


FISCAL Expansion: Investment Demand = Savings

interest rate FISCAL Expansion:

Money Demand = Supply

GDP

Keynes’s Liquidity Trap: Keynes’s Liquidity Trap:


Investment Demand = Savings

interest rate


GDP


interest rate MONETARY Expansion:


GDP






GDP






GDP


Keynesian Multiplier: EvidenceKeynesian Multiplier: Evidence


Source: IMF World Economic Outlook and IMF Fiscal Monitor, Oct. 2012

Another Illustration: Multiplier > 1Another Illustration: Multiplier > 1


NY Times, Oct. 23, 2012

Okun’s Law (1): Unemployment GapOkun’s Law (1): Unemployment Gap


Oct. 24, 2012

Okun’s Law (2):Okun’s Law (2): Output GapOutput Gap


Oct. 24, 2012

Okun’s Law (3)Okun’s Law (3)


Okun’s Law (4)Okun’s Law (4)


Oct. 17, 2012

Output Gap ≈ 20% GDPOutput Gap ≈ 20% GDP http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08-http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08-

Outlook_Testimony.pdfOutlook_Testimony.pdf

A little Stimulus Math:A little Stimulus Math:

20% * $14 tr. = $2.8 tr.20% * $14 tr. = $2.8 tr.

Stim*1.5 = $2.8 => Stim*1.5 = $2.8 => Stim = $1.87 tr.Stim = $1.87 tr.


(2) Bottom Still a Ways Off(2) Bottom Still a Ways Off Okun’s Law, and Slow RecoveryOkun’s Law, and Slow Recovery Housing RecoveryHousing Recovery probably still a year probably still a year

away.away. Credit Markets Credit Markets still very weak.still very weak. Stock Market Valuation Ratios Stock Market Valuation Ratios like P/E like P/E

and Tobin’s Q are now only at and Tobin’s Q are now only at historical historical averagesaverages..

UnemploymentUnemployment Trend Trend: : http://cr4re.com/charts/charts.htmlhttp://cr4re.com/charts/charts.html


HousingHousing BottomBottom – A Long– A Long WayWay OffOff


http://www.nytimes.com/imagepages/2008/10/16/business/16housing.graphix.ready.html


Why it Matters to EveryoneWhy it Matters to Everyone

Worst Long-Term UnemploymentWorst Long-Term Unemployment


Oct. 17, 2012

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

Long Unemployment DipLong Unemployment Dip

Wednesday, April 19, 2023Wednesday, April 19, 2023 4040http://cr4re.com/charts/charts.html

(3) CT & NY in “Middle of Pack”(3) CT & NY in “Middle of Pack”

Financial Sector down, but ..Financial Sector down, but .. Conventional Banking and Insurance Conventional Banking and Insurance

less vulnerable than Investment less vulnerable than Investment Banks, Financial InsuranceBanks, Financial Insurance

Defense industries well insulatedDefense industries well insulated Pharmaceuticals and Biotech have Pharmaceuticals and Biotech have

good long-term prospectsgood long-term prospects House Price Increases near US Avg.House Price Increases near US Avg.Wednesday, April 19, 2023Wednesday, April 19, 2023 4141

International Housing PricesInternational Housing Prices



Sun Belt, Rust Belt ConcentrationSun Belt, Rust Belt Concentration


2006 Peak of Price-to-Rent2006 Peak of Price-to-Rent

Wednesday, April 19, 2023Wednesday, April 19, 2023 4545Source: NY Times, April 20, 2010

(4) More Federal Deficit Spending (4) More Federal Deficit Spending (not Tax Cuts) Necessary(not Tax Cuts) Necessary

Tax cuts to the rich more likely to be Tax cuts to the rich more likely to be saved, not spent or invested.saved, not spent or invested.

Tax cuts don’t have big effect on Tax cuts don’t have big effect on those too poor to pay many taxes.those too poor to pay many taxes.

Unmet needs in Energy, Environment, Unmet needs in Energy, Environment, Health, and Education: good reasons Health, and Education: good reasons to spend.to spend.


Government Must Government Must Increase Increase SpendingSpending in Severe Recession in Severe Recession

“ “ If the Treasury were to If the Treasury were to fill old bottles with fill old bottles with banknotesbanknotes, bury them at suitable depths in , bury them at suitable depths in disused coal mines …disused coal mines …

It would, indeed, be It would, indeed, be more sensible to build more sensible to build

houses houses and the like; but if there are and the like; but if there are political and practical difficulties in the political and practical difficulties in the way of this, the above would be better way of this, the above would be better than nothing.” than nothing.” (Keynes, (Keynes, General TheoryGeneral Theory, 1937), 1937)


But We Need But We Need Foreign Coordination Foreign Coordination for US Expansion to be Successfulfor US Expansion to be Successful

Benefits of lone expansion “leak Benefits of lone expansion “leak out,” other countries free ride.out,” other countries free ride.

Alternatives to joint expansion are Alternatives to joint expansion are protectionism and competitive protectionism and competitive devaluations.devaluations.

US long-term “Fiscal Gap” makes US long-term “Fiscal Gap” makes lone expansion untenable. lone expansion untenable.



Long Term Fiscal Gap: Long Term Fiscal Gap: UnsustainableUnsustainable

http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf


Sure asSure as DebtDebt and Taxes and Taxes

http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf


Implications of Limited Pass-ThroughImplications of Limited Pass-Through

Linda Goldberg (FRBNY) has shown that Linda Goldberg (FRBNY) has shown that

Dollar DevaluationDollar Devaluation means: means:• Improved Earnings on Foreign AssetsImproved Earnings on Foreign Assets• Easier Debt ServicingEasier Debt Servicing• Smaller Trade DeficitSmaller Trade Deficit

And at the same time,And at the same time,

• Minimal Costs in further InflationMinimal Costs in further Inflation

So - What’s Not to Like?So - What’s Not to Like?• FRBNY Governor Frederic Mishkin says FRBNY Governor Frederic Mishkin says

“Devaluation cannot be a policy.” (I think he “Devaluation cannot be a policy.” (I think he means an means an explicitexplicit policy.) policy.)

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



Inflation/Devaluation Inflation/Devaluation a Powerful Temptation for a Powerful Temptation for

Highly Indebted GovernmentsHighly Indebted Governments

• Germany after WWI• Russia after the Revolution• Soviet Union after the Cold War• Many Developing Countries after spending, investment binges

(See L. Kotlikoff & S. Burns, The Coming Generational Storm, 2004)


Inflation/Devaluation Appears Inflation/Devaluation Appears a “Painless” Way Out of Debta “Painless” Way Out of Debt

Summary of ConclusionsSummary of Conclusions RecessionRecession is is long and deeplong and deep: housing slump, : housing slump,

interbank lending, financial markets likely to interbank lending, financial markets likely to “overshoot” on low side.“overshoot” on low side.

CT, NYCT, NY are “ are “middle of the packmiddle of the pack” for housing ” for housing prices and employment stability.prices and employment stability.

Greatly expanded federal spending Greatly expanded federal spending is is needed in the needed in the short-termshort-term..

Long-termLong-term, however, US government , however, US government debt is debt is unsustainableunsustainable..


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