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LessonsfromtheFinancialCrisisand
SlowRecovery
for
Teaching
Economics
JohnB.
Taylor
StanfordUniversity
October27,
2011
7th AnnualEconomicTeachingConference
Cengage Learning,Gulf
Coast
Economics
Association
NewOrleans,Louisiana
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Outline Differentviewsofthefinancialcrisis,recession,and
recovery Not
surprisingly,
economists
disagree!
Differentimplicationsforteaching Exampleswillbepresentedthroughouttalkbasedon
EmpiricalResearch
UndergraduateTeaching Economics1atStanford
Textbook PrinciplesofEconomics,7e,withWeerapana atWellesley FirsttoincorporatetheFinancialCrisis,
First2eonthefinancialcrisis
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Narrative Economic
policy
deviated
from
basic
economic
principleswhichhadworkedwell
Result? Agreatrecession,afinancialpanic,andavery
weak,
nearly
nonexistent
recovery.
Thedeviationsbeganwithpoliciessuchas amonetarypolicywithinterestratestoolowfortoolong
aregulatory
policy
which
failed
to
enforce
existing
rules
Thedeviationsfromsoundprinciplescontinuedwhengovernmentrespondedwithanadhocbailout
processand
temporary
stimulus
programs
Thegoodnews:economicgrowthandstabilitycanberestoredbyadoptingpoliciesconsistentwith
basiceconomic
principles.
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OtherNarrative
USpolicywasnotanissueleadinguptothe
crisis Globalcapitalflowsweretheproblem
Caused200709crisis:globalsavingsglut
Oreconomics
failed
Toomuchfaithinmarkets
Notenoughpsychology
Slowrecoverybecausetheinterventionsweretoosmall;needmore
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ImplicationofTwoViewsforBasicEconomics
1.Basicallysound,butstillamajorteaching
moment
2.Needs
areformulation
PaulSamuelson(January2009)
todayweseehowutterlymistakenwastheMiltonFriedman
notion
that
amarket
system
can
regulate
itselfThisprevailingideologyofthelastfewdecades
hasnowbeenreversed.
PaulKrugman blames
modern
economics
(especiallymacro)forthecrisis.
Butofcourseneedtopresentbothviews
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EKGfortheAmericanEconomy
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IllustrativemonetarypolicychartfromSan
Francisco
Fed,
March
1995,
Judd
and
Trehan
198792
199394
196579
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IllustrativemonetarypolicychartfromStLouisFed
February
2007,
Bill
Poole
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PolicyDeviationsLeadinguptothe
Crisisand
the
Panic
in
Fall
2008
Interestratestoolowfortoolong
Discretionaryfiscal
stimulus
of
Feb
08
($152B)
Onagain,offagainbailoutsfinancedbycentralbanksbalancesheet
on forBSCcreditorsbailout,off forLehmancreditorsbailout,on forAIGcreditorsbailout,off forTARProleout
Governmentregulatorsandsupervisorsdeviatedfromsoundregulatoryrules,especiallyatlargebanks
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IllustrativemonetarypolicychartfromStLouisFed
February
2007,
Bill
Poole
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IllustrativemonetarypolicychartfromStLouisFed
February
2007,
Bill
Poole
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ChartfromThe Economist
(Nowin
Economics
in
Action
box)
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TheBoomBustinHousing
(nowin
Economics
in
Action
box)
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HousingBoomandBust
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Temporarystimulusmeets
permanentincome
hypothesis
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Stock PricesDuringthePanic
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TeachingAboutRegulatoryCapture:Explains
failure
to
enforce
regulatory
rules
Cozyconnectionsbetweengovernment
and
the
financialindustry.
Thisbook
shows
governmenthelpingwell
connectedindividuals,who
inturn
helped
the
governmentofficials.
Result:Recklesspolicy
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Linesfrom
Fight
of
the
Century
Keynes:Evenyoumustadmitthatthelessonwevelearnedisthatmoreoversightsneededorelsewellgetburned
Hayek:Oversight?ThegovernmentslongbeeninbedwiththoseWallStreetexecsandthe
firmsthattheyveled.
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Policymakers
then
doubled
down
Discretionaryfiscalstimulusof2009($862billion)
Onetime
payments
again
Moregovernmentspendingtoo
Cashforclunkersprogram
Quantitativeeasing
in
2009,
now
called
QE1
Purchasesof$1.25trillionofmortgagebackedsecurities,$300billionoflongertermTreasurybonds
QE2in
2010
and
2011
purchasesof$600billionoflongertermTreasurybonds.
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IncomeandConsumptionduringtheTwo
Discretionary
StimulusPrograms
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Cashforclunkers:incentivesreallymatter
(Nowin
Economics
in
Action
box)
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Comparewithtextbookdiscussion:
Sharpdrop
in
Icauses
expenditure
line
to
shift
down
45-degree line
NewE line
Original E line
Original
incomelevel
New
incomelevel
INCOME OR REAL GDP
SPENDING
Income or real GDP falls by this amount
(more than by amount I falls ).
I falls by this
amount
Original point
of spending
balance
New point of spending balance
25_10
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OffsetbyCountercyclicalfiscalpolicy
Increasein
G
raises
GDP
depending
on
size
of
the
multiplierandamountofcrowdingout
45-degree line
INCOME OR REAL GDP
SPENDING
G rises
25_10
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0
50
100
150
200
250
300
350
400
09Q1 09Q2 09Q3 09Q4 10Q1 10Q2 10Q3 10Q4
Billions of dollars, annual rates
--- Federal government investment--- Federal government consumption
--- Grants to state and
local governments
--- Temporary transfer
payments and credits
to persons
Two-Year Effect of ARRA on Major Federal Budget Categories(Source: Bureau of Economic Analysis)
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1,400
1,500
1,600
1,700
1,800
1,900
2,000
2,100
2,200
2,300
2005 2006 2007 2008 2009 2010
Total receipts of state
and local governments
Recepits less
ARRA grants
Purchases by state
and local governments
Billions of dollars, annual rates
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A Legacy:ExplodingFederalDebt
(Chartnow
in
Fiscal
Policy
Chapter)
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TowardtheZeroInterestRate
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TheLiquidityTrap
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TheMonetaryBaseandtheSize
ofthe
Feds
Balance
Sheet
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InternationalEconomicsIssues
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IllustrativeChartfromtheOECD,March2008
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IllustrativeChartfromtheOECD,March2008
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Chinaspurchasesofforeignreserves
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SoWhy
Do
Economists
Disagree?
Studentsandeveryoneelsereallywantto
knowthe
answer
Onereasonisthatthedetailsoftheirmodelsaredifferent,eventhoughthereisagreement
aboutthe
basic
principles
ThenextthreechartsfromtheNewYorkTimes illustrate
this
well.
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-1
0
1
2
3
4
5
6
2009 2010
With stimulus
If no
stimulus
-1
0
1
2
3
4
5
6
2009 2010
With st imulus
If no
stimulus
The accumulation of hard data and real-life
experience has allowed more dispassionate analysts to
reach a consensus that the stimulus package, messy
as it is, is working
New York TimesNovember 12, 2009
NewKeynesian
Smets ECB
RobertBarro
Harvard
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ImplicationsforTeaching
Manynew
illustrations
of
basic
economics
Interestingdebatesbetweeneconomists Rulesversusdiscretion
Basicrole
of
government
Moreintegrationofmicroandmacro interestratestoolowfortoolong(macro)
housingmarkets
including
bubbles
(micro)
stimuluspackage(macro)
regulatorycaptureandmoralhazard(micro)
newinstruments
of
monetary
policy
(macro)
riskpremia ininterestrates(micro)
debateoversizeofmultipliers(macro)
cashfor
clunkers,
first
time
home
buyer
(micro)
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ManyNewYouTubeVideos
QuantitativeEasingExplained.5milliondownloads.Doesn'tgetitallrightandbrutalinplaces,butgoodfordiscussion
TheWrongFinancialAdviser CreatedbyNobelprizewinner
BillSharpe
FedChairman ontheDailyShowwithJonStewart.Fromtwodifferentepisodesof60Minutes,focusonwhetherquantitativeeasingisprintingmoney.
UnmaskingInterest
Rates,
Honky
Tonk Style
MerleHazardsings"InflationorDeflation
InsideJobTrailer
ChristineLagarde inclipfromInsideJobHayek
Keynes
rap
videos
"Fear
the
Boom
and
Bust
and
Fight
oftheCentury