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L f h Fi i l C i i fLessonsfromtheFinancialCrisisforTeachingEconomicsg
John B TaylorJohnB.TaylorStanfordUniversity
June2,2011
NationalConferenceonTeachingEconomicsandResearchinEconomicEducation
OutlineOutline NarrativeoftheFinancialCrisis
Informsonesviewsaboutlessonsforteaching AlternativeNarratives
N t i i l i t di Notsurprisingly,economistsdisagree ImplicationsforTeaching
Examples will be presented throughout talk based on Exampleswillbepresentedthroughouttalkbasedonexperience
Graduate(1styearPh.D.courseatStanford) Undergraduate(Economics1atStanford) Textbook(PrinciplesBookwithWeerapana)
NarrativeE i li d i t d f b i i Economicpolicydeviatedfrombasiceconomicprincipleswhichhadworkedwell
Result? A great recession a financial panic and a Result?Agreatrecession,afinancialpanic,andaveryweak,nearlynonexistent,recovery.
The deviations began with policies such asThedeviationsbeganwithpoliciessuchas amonetarypolicywithinterestratestoolowfortoolong aregulatorypolicywhichfailedtoenforceexistingrulesg y p y g
Thedeviationsfromsoundprinciplescontinuedwhengovernmentrespondedwithanadhocbailoutprocessandtemporarystimulusprograms
Thegoodnews:economicgrowthandstabilitycanberestoredbyadoptingpoliciesconsistentwithbasiceconomicprinciples.
Anillustrationthatbasicprinciplesworkwell,whenfollowed
15
20Percent
GreatModerationperiod
10
15 period
0
5
-5
0
G t R i
-15
-10GreatRecession(EndofGreatModeration?)
50 55 60 65 70 75 80 85 90 95 00 05 10
Growth Rate of Real GDP
IllustrativemonetarypolicychartfromSanFranciscoFed,March1995,JuddandTrehan
196579
198792
199394
IllustrativemonetarypolicychartfromStLouisFedFebruary2007,BillPooley
PolicyDeviationsLeadinguptothed h llCrisisandthePanicinFall2008
Interestratestoolowfortoolongg DiscretionaryfiscalstimulusofFeb08($152B) Onagain offagain bailouts financed by centralOnagain,offagainbailoutsfinancedbycentralbanksbalancesheet on for BSC creditors bailout off for Lehman creditorson forBSCcreditors bailout,off forLehmancreditors bailout,on forAIGcreditorsbailout,off forTARProleout
Government regulators and supervisors deviatedGovernmentregulatorsandsupervisorsdeviatedfromsoundregulatoryrules,especiallyatlargebanks
IllustrativemonetarypolicychartfromStLouisFedFebruary2007,BillPooley
IllustrativemonetarypolicychartfromStLouisFedFebruary2007,BillPooley
ChartfromKansasCityFed,2009,TomHoenig
(20002009)
TheBoomBustinHousingStartsCompared with the CounterfactualComparedwiththeCounterfactual
IllustrativeChartfromtheOECD,March2008
IllustrativeChartfromtheOECD,March2008
Temporarystimulusmeetspermanentincomehypothesisp yp
ThePanicofFall08
Policy makers then doubleddownPolicymakersthendoubled down
Discretionaryfiscalstimulusof2009($862billion)sc et o a y sca st u us o 009 ($86 b o ) Onetimepaymentsagain Moregovernmentspendingtoo
Cashforclunkersprogram Quantitativeeasingin2009,nowcalledQE1
Purchasesof$1.25trillionofmortgagebackedsecurities,$300billionoflongertermTreasurybonds
QE2 i 2010 d 2011 QE2in2010and2011 purchasesof$600billionoflongertermTreasurybondsbonds.
Temporarystimulusmeetspermanentincomehypothesisagainp yp g
Cashforclunkers:incentivesreallymatter
400Billions of dollars, annual rates
300
350
200
250 --- Temporary transfer payments and credits
t
150
200
G t t t t d
to persons
50
100
F d l t ti
--- Grants to state and local governments
009Q1 09Q2 09Q3 09Q4 10Q1 10Q2 10Q3 10Q4
--- Federal government investment--- Federal government consumption
Two-Year Effect of ARRA on Major Federal Budget Categories (Source: Bureau of Economic Analysis)
2,300Billions of dollars, annual rates
2 100
2,200
,Total receipts of stateand local governments
2,000
2,100
Recepits less
1,800
1,900p
ARRA grants
1 600
1,700 Purchases by state and local governments
1,500
1,600
1,4002005 2006 2007 2008 2009 2010
Stateandlocalgovernmentsalsoconsiderpermanentincome
Comparewithtextbookdiscussion:Sharp drop in I causes expenditure lineSharpdropinIcausesexpenditureline
toshiftdown
45-degree line
SPENDING25_10
New E line
Original E lineOriginal point of spending balance
I falls by this amount
Income or real GDP falls by this amount (more than by amount I falls ).
New point of spending balance
Original income level
New income level
INCOME OR REAL GDP
(more than by amount I falls ).
OffsetbyCountercyclicalfiscalpolicyIncreaseinGraisesGDPdependingonsizeofthep g
multiplierandamountofcrowdingout
45-degree line
SPENDING25_10
G rises
INCOME OR REAL GDP
Butlookwhathappened
6Percent, annual rate
Growth rate of real GDP
2
4
0Contribution of
-4
-2 government purchases
-6
-807Q1 07Q3 08Q1 08Q3 09Q1 09Q3 10Q1 10Q3
QuantitativeEasingFinancedbyMonetaryBase
2,800Billions of dollars
2,400Monetarybase(currencyplusreserves)
2,000
1,600
1,200
800Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11
AWonderfulTeachingMoment:The Money Multiplier and the Monetary BaseTheMoneyMultiplierandtheMonetaryBase
Percent
800
1,000CBO Outlook in 2010
600
800
Federal Debt as a
CBO Outlook in 2009
400
600 Federal Debt as aPercent of GDP
200
400
0
200
CBO Outlook in 2011??0
1800 1850 1900 1950 2000 2050
TeachingAboutRegulatoryCapture:E l i f il t f l t lExplainsfailuretoenforceregulatoryrules
C ti b t Cozyconnectionsbetweengovernmentandthefi i l i d tfinancialindustry.
Bookshowsgovernmenthelpingwellconnectedindividuals,whointurnhelpedthegovernmentofficials.
Result:Recklesspolicy
ImplicationofNarrativeforBasicEconomics
Needsareformulation? PaulSamuelson(January2009)PaulSamuelson(January2009)
todayweseehowutterlymistakenwastheMiltonFriedmannotionthatamarketsystemcanregulateitselfThisprevailing ideology of the last few decades has now beenprevailingideologyofthelastfewdecadeshasnowbeenreversedIwishFriedmanwerestillalivesohecouldwitnesshowhisextremismledtothedefeatofhisownideas.
PaulKrugman blamesmoderneconomics(especiallymacro)forthecrisis.
B t ti h i li b i i k Butnarrativehereimpliesbasiceconomicsworks Thecrisiswascausedbyadeviationfromprinciples
f h h h d Butofcoursethereismuchresearchtodo
Another NarrativeAnotherNarrative
US policy was not an issue leading up to theUSpolicywasnotanissueleadinguptothecrisisandisnotanissuenow
Global capital flows were and are the problem Globalcapitalflowswereandaretheproblem Causedemergingmarketcrisesin1990sC d 2007 09 i i S i Gl Caused200709crisis:SavingGlut
Causeoffuturecrises:focusonglobalrebalancing Muchdifferentpolicyimplication
ButchartfromtheIMFin2005ShowsNoGlobalSavingGlut
So Why Do Economists Disagree?SoWhyDoEconomistsDisagree?
Students and everyone else really want toStudentsandeveryoneelsereallywanttoknowtheanswer
One reason is that the details of their models Onereasonisthatthedetailsoftheirmodelsaredifferent,eventhoughthereisagreementabout the basic principlesaboutthebasicprinciples
ThenextthreechartsfromtheNewYorkTi d h ill hi llTimes andtwoothersillustratethiswell.
66
NewKeynesianSmets ECB
RobertBarroHarvard
3
4
5With stimulus
3
4
5
With stimulus
0
1
2If nostimulus
0
1
2If nostimulus
-12009 2010
-12009 2010
The accumulation of hard data and real-lifeThe accumulation of hard data and real life experience has allowed more dispassionate analysts to reach a consensus that the stimulus package, messy p g yas it is, is workingNew York Times November 12, 2009
ImplicationsforTeachingM ill t ti f b i i Manynewillustrationsofbasiceconomics
InterestingdebatesbetweeneconomistsR l di ti Rulesversusdiscretion
Butraisemorequestionsaboutdiscretionarypolicy More integration of micro and macro Moreintegrationofmicroandmacro
interestratestoolowfortoolong(macro) housing markets including bubbles (micro)housingmarketsincludingbubbles(micro) stimuluspackage(macro) regulatorycaptureandmoralhazard(micro) newinstrumentsofmonetarypolicy(macro) riskpremia ininterestrates(micro) debateoversizeofmultipliers(macro) cashforclunkers,firsttimehomebuyer(micro)
ManyNewYouTubeVideosQuantitativeEasingExplained.5milliondownloads.Doesn't
getitallrightandbrutalinplaces,butgoodfordiscussionTheWrongFinancialAdviser CreatedbyNobelprizewinner
BillSharpeFedChairmanontheDailyShowwithJonStewart.Fromtwo
differentepisodesof60Minutes,focusonwhetherquantitativeeasingisprintingmoney.
UnmaskingInterestRates,HonkyTonk StyleMerleHazardsings"InflationorDeflationInsideJobTrailerChristine Lagarde in clip from Inside JobChristineLagarde inclipfromInsideJobHayekKeynesrapvideos"FeartheBoomandBustandFight
oftheCentury
Lines from Fight of the CenturyLinesfrom FightoftheCentury
Keynes: Even you must admit that the lessonKeynes: Evenyoumustadmitthatthelessonwevelearnedisthatmoreoversightsneededor else well get burnedorelsewe llgetburned
Hayek:Oversight?Thegovernmentslongbeenin bed with those Wall Street execs and theinbedwiththoseWallStreetexecsandthefirmsthattheyveled.