money, financial crises, and business cycles
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Money, Financial Crises, and Business Cycles. Edward C. Prescott July 7, 2010. Messages. Monetary Policy has little real effects Financial crises are symptoms and not cause of economic downturns – crises sometimes lead to good regime changes and sometimes to bad - PowerPoint PPT PresentationTRANSCRIPT
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Money, Financial Crises, and Business Cycles
Edward C. PrescottJuly 7, 2010
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Messages
• Monetary Policy has little real effects
• Financial crises are symptoms and not cause of economic downturns – crises sometimes lead to good regime changes and sometimes to bad
• A big looming problems is efficiently financing retirement consumption – it can be done
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Macro Theory Works
• Given productivity, population, and taxes:
– Predicted and actual paths of the aggregate variables coincide
– All using dynamic economic theory to construct models consistent with the national accounts and other data find same thing
– All find monetary policy had little real impact
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What Gave Rise to Post 1960 Contractions and Expansions?
• All graphs per working-age person and adjusted for secular living standard growth
• Flat line is healthy trend growth with living standards doubling every generation
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The Biggest ExpansionTechnology Driven
90
95
100
105
110
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
* Quarterly trend growth: 0.45%
Period Average = 100
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The Biggest ContractionTax Rate and Productivity Driven
90
95
100
105
110
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
* Quarterly trend growth: 0.45%
Period Average = 100
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The Longest ExpansionTax Rate and Productivity Driven
90
95
100
105
110
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
* Quarterly trend growth: 0.45%
Period Average = 100
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The 1990s ExpansionTechnology Driven
90
95
100
105
110
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
* Quarterly trend growth: 0.45%
Period Average = 100
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Best Indicator of Current Situation is Market Hours, Not GDP!
• I use household survey measures of hours worked (CPS)
• There are serious problems with establishment based hours estimates
• GDP is only part of output and is revised in major ways as more data becomes available
• CPS market hours are revised little
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Source: Cociuba (FBR Dallas), Prescott (ASU & FBR Minn.), and Ueberfeldt (Bank of Can.)
1200
1300
1400
1500
1600
Trough: 2009-III
Peak: 2008-II
US Annual Hours per Working Age Person 2001-I to 2010-I
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Hours Drop between 2008.II and 2009-III
11 %!
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Has Output Started to Recover?
NO! • Businesses have cut intangible capital investment
– R&D, human capital investment, advertising
• Intangible investment is not part of measured output – because it is expensed
Output = GDP + Intangible capital investment
• Preliminary detrended GDP flat last three quarters
• Detrended output almost surely fell
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Note: Fluctuations Not Due to Monetary Policy!
• Nor lack of borrowing
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Liabilities of Households and of Nonfinancial Businesses They Own
End 2007 End 2008 End 2009
Total Liabilities (trillion US$) 32.5 33.2 32.9Composition Shares Mortgages 44.9% 44.4% 43.1% Business Borrowing 38.3% 39.5% 39.3% Other 16.8% 16.1% 17.6%
Source: Flow of Funds, March 11, 2010 Release, Tables L100 and L101
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Reason for Not so Great Current Depression is NOT Recent Financial Crisis!
• Businesses have funds or access to borrowing to make profitable investments
• Currently U.S. banks are lending huge amounts to the Federal Reserve Banks
• This lending is at a low rate– 0.25% nominal– negative real
• Problem: Banks do not have good lending opportunities
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Then What Depressed the U.S. Economy
• Fact: Investment suddenly became depressed beginning early in 2008 – because of a policy regime change
• Business owners feared higher tax rates with the regime change and – Rationally cut investment – Rationally cut employment – Rationally took more cash out of business
• Workers fearing job loss rationally cut auto buying
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Private Investment Is Depressed (2006 Q4 = 1)
0.4
0.6
0.8
1
1.2
1.4
I/Y
C/Y
G/Y
2001 2002 2003 2004 2005 2006 2007 2008 2009
Y GDPC Private ConsumptionI Private InvestmentG Government Expenditures
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Fears Are Being Realized
• Tax rates are being increased
• These increases lower amount of capital a firm chooses to have
• Reason for low investment is not problem of getting loans – it is expected future high tax rates
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What Happened after Financial Crises?
Sometimes bad thingsand
Sometimes good things
Numbers are trend corrected so flat line is growing at trend
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Finland Good and Japan Bad
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
60
80
100
120
140GDP per Capita Detrended at 2% 1992 = 100
Source: GGDC (PPP-EKS) Japan
Finland
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1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
60
80
100
120
140
Chile Great and Mexico Terrible Detrended at 2% 1980 = 100
Chile
Mexico
Source: GGDC (GK-PPP)
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Others Financial Crises
• U.S. 1981: good policy regime change
• U.S. 1989-90 : bad change
• Asia 1997 : good change
• U.S. 2008 : bad change
• Euro Zone 2010: probably good change
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What are Good and Bad Policy Regime Changes?
• Good: Cut tax rates and therefore expenditures; Follow productivity growth policies
• Bad: increase expenditures and therefore taxes now and/or in the future; cater to special interest groups which blocks productivity growth
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A Looming Financial Problem:Financing Retirement Consumption
• The ratio of retirees to workers is going up
• Can’t increase transfers to old because higher tax rates will not increase revenue
• With current tax system there will be an over-accumulation of capital and dynamic inefficiency
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U.S. Has a Big Capital Stock:5.8 GNPs
Legal Ownership
Stock Source
Government 0.6 GNPs BEA
Tangible Private 3.5 GNPs BEA
Intangible Private 1.7 GNPs McGrattan & Prescott, AER,
Sept 2010Total 5.8 GNPs
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But, most is Owned by the Government
Economic Ownership
Stock in GNPs
Government 3.0
Private 2.8
Total 5.8
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What Can Be Done?
Answer: Eliminate taxes on capital income!
• Will increase private saving stock net of government debt
• Will increase the market value of businesses by– Shifting most of its ownership from the public to
private sector • Will increasing private saving opportunities
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Legal and Economic Ownership are Different Concepts and it is the Economic Concept that
must be Used in Economic Analyses
• Economic ownership of a stream of distributions means that the owner can transform this stream into an equal valued stream of consumption
• If 50% of a legally owned stream is taken as taxes, economic and government ownership are both 50%
• The tax on pension payments is approximately 50% in the U.S. so the government owns half our pension savings
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There are Solutions to the Problems
• The Saving for Retirement Problem– Solution – Shifting economic ownership of a large
part of the capital stock from the public to the private sector by eliminating capital income taxes
• The Current U.S. Depression– Cut tax rates and expenditure and stop catering to the
special interests groups