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Why Is the Recovery from the
Financial Crisis So Sluggish?
Robert E. HallHoover Institution and Department of Economics
Stanford University
Keynote AddressAgricultural and Applied Economics Association
PittsburghJuly 24, 2011
·
1
U.S. Employment Rate for
Workers Aged 25 through 54
97
98
95
96
Normal
93
94
92
93
90
91
88
89Slump Slump Slump Slump
87
1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
2
Payroll employment relative to
lowest value in the cycle
1 00
1.02
1.04
1.06
1.08
1.10
1.12atio to
lowest v
alue
Current
1980 to 1985
0.94
0.96
0.98
1.00
‐24 ‐18 ‐12 ‐6 0 6 12 18 24 30 36
Ra
Months from lowest value
3
The basic story, phase I
Real-estate binge in the 2000s
Buildup of housing and consumer durables
Buildup of mortgage, car, and credit-card debt
Financial institutions thinly capitalized
·
4
The basic story, phase II
Real-estate prices began to fall in 2007 and have fallen eversince
Financial institutions failed because of declining asset values;others severely stressed
Credit to households dramatically tightened
Homebuilding and consumer spending declined sharply andremains low today
·
5
Ratios of capital and durables to
GDP
1.6
1.8
Housing and
1.4consumer durables
1.0
1.2
B i i l
0.8
Business capital
0.4
0.6
0.2
0.0
1990 1995 2000 2005
6
Burden of Debt Service
‐5
0
5
10
of to
tal con
sumption
‐15
‐10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Percen
t o
7
Spread, in Percentage Points,
between Business Loan Rates and
Banks’ Borrowing Rate
1.5
2.0
2.5
3.0
3.5
, percentage po
ints
0.0
0.5
1.0
2000 2002 2004 2006 2008 2010
Spread
8
Spread, in Percentage Points,
between Credit-Card Rates and
Banks’ Borrowing Rate
6
8
10
12
14
16
, percentage po
ints
0
2
4
6
2000 2002 2004 2006 2008 2010
Spread
9
Spread, in Percentage Points,
between Mortgage Rates and
10-year Treasurys
1.5
2.0
2.5
3.0
3.5
d, percentage po
ints
0.0
0.5
1.0
2000 2002 2004 2006 2008 2010
Spread
10
Indexes of Lending Standards
Inferred from the FRB Senior
Loan Officer Survey
5
6Mortgages
3
4
2
3
0
1Credit cards
‐1 Business loans
‐3
‐2
‐4
2003 2005 2007 2009
11
Index of Google Search Queries
for the Term “withdrawal
penalty”
70
80
60
70
50
30
40
20
30
10
0
2004 2005 2006 2007 2008 2009 2010 2011
12
Index of Google Search Queries
for the Term “beer”120
100
80
60
40
20
0
2004 2005 2006 2006 2007 2008 2009 2010
13
The near-exogeneity of inflation
in today’s economy
6
8
10
12
Unemployment rate
0
2
4
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
One‐year‐ahead inflation forecast
14
Annual Percent Changes in
Output and Prices, 2007 Q4 to
2009 Q410
CSIE XS
MG
MS FDFN
SL
5
price
CD CNIS
IR XG
MG SL
5
0
chan
ge in
10
‐5
l percent c
‐15
‐10
Ann
ua
‐20
15
‐20 ‐15 ‐10 ‐5 0 5 10
Annual percent change in output
15
Real rate of interest
The real rate is the nominal rate minus the rate of inflation.
Thus, if the nominal rate zero, the real rate is minus the rateof inflation.
If the rate of inflation is exogenous, the real rate is pinned atminus the rate of inflation.
·
16
The problem
12
Normal demand functionSupply function
8
4t rate
Normal employment and normal interest rate
0Interest
4
0
8
‐4
‐80 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6
Employment
17
The problem
12
Normal demand functionSupply function
8
4t rate
Normal employment and normal interest rateCrisis
0
Interest
Crisis demand function
4
0
Normal employment and l i i i
8
‐4 low crisis interest rate
‐80 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6
Employment
18
The problem
12
Normal demand functionSupply function
8
4t rate Normal employment and
normal interest rateCrisis
0Interest
Crisis demand function
‐4
0
Normal employment and‐2.58
‐4 Normal employment and low crisis interest rate
5‐8
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6
Employment
19
The interest rate fails to do its
job
12Supply function
8
4t rate
Crisis demand function
Excess
0Interest supply
Interest rate pinned at zero
4
0
8
‐4
‐80 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6
Employment
20
A Long Period with the Nominal
Short Rate Pinned at Zero
4.0
4.5
Actual CBO forecast
3.5
4.0
2.5
3.0
per year
2.0
2.5
, percent
1 0
1.5
Rate,
0.5
1.0
0.0
2008 2009 2010 2011 2012 2013 2014 2015
21
Monetary policy
Normal: Fed can stimulate by issuing more reserves, whichcauses banks to expand lending and lower interest rates
Since October 2008: Fed has driven the safe nominal shortrate to zero but pays a bit of interest on reserves, so banksjust keep added reserves and the Fed cannot expand lendingand push the interest rate below zero
The Fed has some limited ability to lower longer-maturityinterest rates by issuing reserves and using the proceeds to buylonger-maturity bonds—quantitative easing (QE)
·
22
Effect of QE2 on bond interest
rates
Security Decline in interest rate, basis points
30-year Treasury bond 21
10-year Treasury note 3010-year Treasury note 30
5-year Treasury note 20
1-year Treasury bill 1
Long investment-grade coporate 19
Intermediate investment-grade corporate 16g p
Long junk corporate 13
Intermediate junk corporate -17
A basis point is 1/100 of a percentage point 23
Effect of QE2 on expected
inflation
Inflation swap, years into futureIncrease in expected future inflation, basis
points
30 4
10 4
5 4
1 5
A basis point is 1/100 of a percentage point
24
The Fed’s Exit Strategy and the
Likelihood of InflationThe Fed has bought more than $2 trillion in assets since thecrisis.
Contrary to what you read in the financial press, this was notfunded by printing money, but rather by borrowing from banksand paying interest on the loans (reserves).
When good times finally return, the Fed can use a combinationof assets sales to retire reserves and raising the interest rate itpays on reserves—both would raise interest rates.
Because the Fed is adaptive—it looks at inflation and adjuststo offset it—there should be no concern about inflationresulting from its huge asset holdings.
·25
Inflation outlook
Professional forecasters, 10 year: 2.2 percent
Consumer expectations, 5 to 10 year: 3.0 percent
Treasury inflation-protected breakeven, 5 year: 2.9 percent
The inflation hawks have failed to convince the professionals,consumers, or investors...
·
26
Fiscal policy: Government
purchases
60
80 Beginning of recession
Stimulus bill passed
40
ars
recessionFederal
0
20
007 do
lla
‐40
‐20
ions of 2
0
Sum of F d l St t
‐60
‐40
Bill Federal, State,
‐100
‐80 State and Local
27
Fiscal policy: Transfers
100
150
200
250
300
ions of 2
007 do
llars
Beginning of recession
Stimulus bill passed
Extra Government Benefits to Individuals
0
50
100
2007‐IV 2008‐IV 2009‐IV
Bill
28
Effects of fiscal policy
Purchases Transfers Total
Average federal stimulus, 2009Q2-2010Q1 58 220
Multiplier 2 0.8
Effect 115 176 291
GDP 14,338
Percent of GDP 0.8 1.2 2.0
Average GDP shortfall 8.2
Counterfactural GDP shortfall 10.2
29
Exotic fiscal policy
A gradual switch to a consumption tax that is added toproduct prices rather than subtracted from factor incomeswould make current consumption cheaper in nominal termsand eliminate the zero bound.
·
30
Explaining the excruciatingly
slow recovery
Households are still constrained by debt incurred during theboom and by credit tightening from the financial crisis.
The Fed has done almost all that it can—another QE wouldhave close to zero benefit.
No chance of conventional fiscal expansion; rather, possiblecutbacks motivated by excessive federal debt
Even less chance of exotic, revenue-neutral expansion
·
31
For the future...
The main lesson is to avoid the regulatory lapses that causedthe accumulation of housing, its associated debt load, andresulting frictions.
Dodd-Frank has given the federal government a lot of newtools to improve financial oversight, but it remains to see ifthey will be used effectively.
·
32
Material on rising structural
unemployment if time permits
·
33
Total Factor Productivity
120
115
110
105
100
95
90
1999 2001 2003 2005 2007 2009
34
Ratio of UI Benefits to Median
Earnings0.25
0.20
0.15
o
0.10
Ratio
0 050.05
0.00
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
35
Detrended Index of the Labor
Force
1.03
1.04
1.02
1.03
1.00
1.01
0 98
0.99
0.97
0.98
0.95
0.96
0.94
1980 1984 1988 1992 1996 2000 2004 2008
36
Components of Decomposition of
Movements of the Labor Force
0 50
0.60
Trend
0.40
0.50
0.30
0.40
Current employment
0.20Lagged employment
0.10
0.00Random component
‐0.10
1980 1984 1988 1992 1996 2000 2004 2008
37
Total of Components of
Movements of the Labor Force,
except Random Component
1.03
1.04Labor force index
1.02
1.03
Value projected from employment
1.00
1.01
0.98
0.99
0.97
0.98
0.95
0.96
Estimation period through December 20070.94
1980 1984 1988 1992 1996 2000 2004 2008
Estimation period through December 2007
38
Number of Job Openings
4,500
5,000
3 500
4,000
3,000
3,500
nds
2,000
2,500
Thou
san
1,500
,
500
1,000
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
39
Efficiency of Matching
Job-Seekers to Jobs1.2
1.0
0.8
0.6
0.4
0.2
0.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
40
The Beveridge Curve
0.040
rce
December 20000.035
labo
r for December 2000
through July 2009
0 025
0.030
embe
r of August 2009
through August 2010
0.020
0.025
gs per m
e
0.015
0.020
b op
ening
0.010
Job
0.03 0.05 0.07 0.09 0.11
Unemployment rate
41
Counterfactual Beveridge Curve
with Normal Behavior of
Matching Efficiency0.035
ce
December 2000 through July 2009
0.030
labo
r forc
August 2009 through August 2010
0.025
mbe
r of l
0.020
s per m
e
0.015open
ing
0.010
Job
0.03 0.05 0.07 0.09 0.11
Unemployment rate
42
Two Measures of Numbers of
New Hires per Quarter
16 000
18,000JOLTS data
14,000
16,000
10,000
12,000
BED data
8,000
10,000 BED data
4,000
6,000
2,000
0
1992 1994 1996 1998 2000 2002 2004 2006 2008
43
Numbers of Workers Hired and
Numbers of Quits, JOLTS
7,000
5 000
6,000 Hires
4,000
5,000
workers
3,000
usan
ds of w
Quits
2,000
Thou
1,000
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
44
Ratio of JOLTS Hiring Rate and
BED Job-Creation Rate together
with Matching Efficiency2.5
JOLTS separations/BED separations
2.0
1.5
1.0Matching efficiency
0 50.5
0.0
2001 2003 2005 2007 2009
45
Fraction of Unemployed Who
Quit Previous Jobs
0.18
0.20
0.16
0.12
0.14
0.08
0.10
0.06
0.08
0.02
0.04
0.00
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
46
Measuring Mismatch in the U.S.
Labor Market
Aysegul Sahin, Federal Reserve Bank of New YorkJoseph Song, Federal Reserve Bank of New YorkGiorgio Topa, Federal Reserve Bank of New York and IZAGiovanni L. Violante, New York University, CEPR and NBER
·
47
Unemployment without mismatch
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110.04
0.05
0.06
0.07
0.08
0.09
0.1
0.11
Une
mpl
oym
ent R
ate
Date
U.S. Data
Counterfactual Mh
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110.04
0.05
0.06
0.07
0.08
0.09
0.1
0.11
Une
mpl
oym
ent R
ate
Date
U.S. DataCounterfactual Mh
φ
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110.04
0.05
0.06
0.07
0.08
0.09
0.1
0.11
Une
mpl
oym
ent R
ate
Date
U.S. DataCounterfactual Mh
z
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110.04
0.05
0.06
0.07
0.08
0.09
0.1
0.11
Une
mpl
oym
ent R
ate
Date
U.S. DataCounterfactual Mh
x
Figure 8: Counterfactual Unemployment Rates: Industry
28 48
