Wayne CarrollDepartment of EconomicsUniversity of Wisconsin-Eau Clairecarrolwd@uwec.edu

We Survived the Great Recession of

2008-09 –

WHAT NOW?

The Great RecessionStarted in December 2007 and probably

ended around July 2009.

Aug 1929 - March 1933 43 months

Dec 2007 – July 2009 20 months

Nov 1973 - March 1975 16 months

July 1981 - Nov 1982 16 months

July 1990 - March 1991 8 months

March 2001 - Nov 2001 8 months

Source: http://wwwdev.nber.org/cycles/cyclesmain.html

Why was this recession special?The deepest since the Great

Depression.

The government response to this recession was extraordinary and will have a lasting, historic impact.

The economy has been behaving differently from before, so we’re in uncharted territory.

How do we measure recessions?Real GDPTotal employmentUnemployment rateBank creditIndustrial productionHome sales and pricesStock market prices and other asset pricesOthers

The “official” word on recessions comes from the National Bureau of Economic Research (NBER).

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

1970 1975 1980 1985 1990 1995 2000 2005 2010

National Output (Real GDP in billions of 2005 $)

0%

2%

4%

6%

8%

10%

12%

1970 1980 1990 2000 2010

U.S. Unemployment Rate

93%

94%

95%

96%

97%

98%

99%

100%

101%

102%

-5 0 5 10 15 20 25 30

Months before or after employment peak

Total Employment Relative to Peak: The Bad Recessions

2007-09

1974-75

1981-82

What about Wisconsin?Wisconsin tends to follow national economic trends (more or less)

Wisconsin was hit by the recession about as hard as the rest of the nation, and it will probably recover (or not) with the rest of the nation

70

75

80

85

90

95

100

105

1990 1995 2000 2005 2010

Nonfarm Employment Index: Wisconsin and U.S.(Seasonally adjusted; December 2007 = 100)

Wisconsin

U.S.

0%

2%

4%

6%

8%

10%

12%

1990 1995 2000 2005 2010

Unemployment Rates: Wisconsin and U.S.(Seasonally adjusted)

U.S.

Wisconsin

90

92

94

96

98

100

102

2007.5 2008 2008.5 2009 2009.5 2010 2010.5 2011

Nonfarm Employment Index: Wisconsin and U.S.(Seasonally adjusted; December 2007 = 100)

Wisconsin

U.S.

How did we get here?Broad expansion in mortgage lending and

increases in home prices starting in the 1990s.

The housing bubble burst in 2006-7.Many home owners “underwater”Increase in mortgage default ratesFinancial problems for holders of mortgage-

backed securities (http://faculty.chicagobooth.edu/raghuram.rajan/research/TheCreditCrisisDougDiamondRaghuRajanAEADec2008.pdf)

How did we get here?Risks were spread in new ways (or at an

unprecedented scale) in the housing bubble, so the downturn was much broader and deeper than anyone thought was possible. (http://www.hbs.edu/research/pdf/09-060.pdf)

Crisis of confidence recession accompanied by financial crisisConsumers are reluctant to spend or

borrowBanks are reluctant to lendBusinesses are reluctant to invest in

capital projects

Crisis of Confidence

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

$9,000

$10,000

1980 1985 1990 1995 2000 2005 2010

Consumption and Investment Spending(billions of 2005 dollars)

Consumption

Investment

Crisis of Confidence

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

billi

ons

Expenditures on New Housing (Real Private Residential Fixed Investment in billions of 2005 dollars)

How did we get here?

History offers lessons for policy makers:

Recessions can be long-lasting.The Fed did not act decisively in the

Great Depression – it “had to keep its powder dry for a real emergency.”

Japan suffered a deep recession and deflation starting in 1989, and the Japanese government did not respond quickly.

How did we get here?

How did we get here?Learning from history:

The Federal Reserve System has taken extraordinary steps to rescue the financial system.The Fed increased the nation’s money supply at

an annual rate of over 45% in the fourth quarter of 2008.

The Fed has dropped its target interest rate to essentially zero.

The Fed has injected hundreds of billions of dollars into banks, AIG, and other financial institutions.(http://www.federalreserve.gov/monetarypolicy/bst.htm)

http://www.frbatlanta.org/documents/research/highlights/finhighlights/FH_090810.pdf

How did we get here?

Learning from history: Congress and the president(s) enacted fiscal stimulus programs on an unprecedented (peacetime) scale

The stimulus packages have boosted the economy – how much?? – and raised the federal budget deficit.

How did we get here?Emergency Economic Stabilization Act of 2008:

Troubled Asset Relief Program (TARP) – Treasury could spend $700 billion to recapitalize banks

The American Recovery and Reinvestment Act of 2009:$787 billion injection of funds into the U.S.

economy, including $212 billion in tax cuts, in the next ten years(http://cboblog.cbo.gov/?p=208)

President Obama’s latest proposals.(http://www.nytimes.com/aponline/2010/09/10/us/politics/AP-US-Obama.html?scp=2&sq=infrastructure&st=nyt)

The federal budget deficit for fiscal year 2010 was $1.3 trillion dollars, or about 9% of GDP. (http://www.cbo.gov/doc.cfm?index=11705)

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

1950 1960 1970 1980 1990 2000 2010

Federal Budget Deficits as a Share of GDP

Projected debt in 2011 from http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=economic_indicators&docid=f:32au10.txt.pdf

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

1940 1950 1960 1970 1980 1990 2000 2010

National Debt (adjusted for inflation)(Billions of 2010 dollars)

Possible Future Scenarios

A double-dip recession.Many years of deflation and stagnation – like in Japan in the last twenty years.

Fiscal crisis and high inflation as a result of our high national debt

Rapid recovery – like in the early 1980s.

Most likely: a long, slow recovery.

Double-dip Recession?The economy has slowed in recent

months (although it’s still growing).State and local government spending

continues to fall.Federal stimulus spending is

declining.

But the economy will probably continue to grow.

Deflation and Stagnation?

The scary monster hiding under the bed: Japan in the last twenty years .

The 1990s were “the lost decade.”Housing bubble in late 1980s bank crisis

in 1990sSlow growth in real GDP, deflation, and high

unemployment throughout the last twenty years

(http://research.stlouisfed.org/publications/review/10/09/Bullard.pdf)

Deflation and Stagnation?

http://www.economist.com/finance/displaystory.cfm?story_id=13415153

Japan in the last twenty years: what we want to avoid!

Deflation and Stagnation?

Deflation and Stagnation?The Federal Reserve System is trying to

ensure that we’ll have some inflation over the next few years to avoid Japan’s fate:(http://www.federalreserve.gov/newsevents/press/monetary/20100810a.htm)

The Fed probably can keep us out of a deflationary trap.

Fiscal Crisis and High Inflation?

In theory (or maybe in our worst nightmares), a huge national debt could result in:Bankruptcy: the U.S. government might have to default on its debt, causing interest rates to skyrocket (the fate that threatened Greece last spring).High inflation: the government and the Fed might pay off the debt by “printing money,” which would cause inflation.

Fiscal Crisis and High Inflation?Bankruptcy? Not likely.

The U.S. economy “grew out of” deficits in the 1990s and could do it again in the long run.

U.S. Treasury bonds remain an attractive investment around the world.

High inflation? Also not likely.There’s not much evidence of inflation on the horizon.The Fed is on the watch for inflation.

Reducing the deficit (by reducing government spending) would tend to slow the economy further in the short run – not a good move now.

Rapid Recovery or Slow Growth?

Reasons for optimism:There is a lot of excess capacity in the U.S.

economy:Millions of workers looking for workBanks holding more capital and extraordinary

levels of reserves that could be lent outConsumers reducing their debts and their

spending If confidence is restored, the economy could

take off quickly – like it did after the 1981-82 recession.

Rapid Recovery or Slow Growth?

94

96

98

100

102

104

106

108

110

112

114

0 2 4 6 8 10 12 14 16

Quarters after pre-recession peak

National Output Relative to Pre-Recession Peak

1981-82

2007-09

Rapid Recovery or Slow Growth?

95

100

105

110

115

120

0 2 4 6 8 10 12 14 16

Quarters after pre-recession peak

Consumer Spending Relative to Pre-Recession Peak

1981-82

2007-09

Rapid Recovery or Slow Growth?

Reasons for pessimism:Many households are still deeply in debt,

and it will take longer for them to dig out.There’s a lot of excess capacity in the

housing market, so housing starts are not likely to pick up soon.

Many workers have been unemployed (or out of the labor force) for a long time, and their skills are getting rusty. Productivity might fall as they return to work.

My Predictions

2011 will be a good year.2012 will be an even better year.

…unless Congress chooses to cut government spending in the short run, which will slow the recovery.