The Story of Two Recessions The recession of – a supply-shock recession – caused by a reduction in oil supply Price of oil doubled The recession of – a powerful, negative demand shock Home prices – falling Stock prices – plunged 1

An AD and AS Analysis of Two Recessions: Recession 2 Price Level Real GDP AS 1990 Y FE AD 1990 E Y2Y2 P2P2 AS 1991 P1P1 R 1. In 1990, a supply shock from higher oil prices shifted the AS curve leftward … 2. causing output to fall… 3. and the price level to rise

An AD and AS Analysis of Two Recessions: Recession 3 Price Level Real GDP AS 2007 Y FE AD 2007 E Y2Y2 P2P2 P1P1 4. In , a demand shock from several factors caused the AD curve to shift leftward … 5. causing output to fall… 6. and the price level to fall AD 2009 R

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More Real World Examples

An Application Housing & Financial Market Crisis 2007 Nominal Wealth (W) = Financial Assets (Money, Stocks, etc) + Durable Goods Assets (Value of House, etc) - Liabilities (Mortgage, etc)

House Prices fell dramatically in

House Prices Annual Percentage Change

Stock Market Prices Fell Dramatically in 2008 Dow Jones Industrial Average

Effects of Decline in Nominal Wealth W↓ => C↓ => AE↓ = Y ↓ Captured by a shift to the left of AD curve

Y P AD 1 AD 0 AS Y1Y1 P1P1 Y0Y0 P0P0 Effects of Decline in Nominal Wealth - W↓ W↓

Credit Market Effects Tighter credit markets –Higher Interest Rates and/or –Stiffer Terms for Borrowing Declines in –Purchases of New Houses –Purchases of New Plant & Equipment –Consumer Durables Spending (e.g., Autos) AD-AS Model Effects –Decline in Investment Spending –Further Decline in Consumption Spending –AD shifts further to the left

Y P AD 1 AD 0 AS Y1Y1 P 2 Y0Y0 P0P0 Effects of Decline in Nominal Wealth and Tighter Credit Market AD 2 P1P1 Y2Y2 W↓ Tight Credit

Real GDP Growth

Obama Stimulus Package American Recovery and Reinvestment Act of 2009 (ARRA) Passed by Congress on February 13, 2009 and signed into law by President Obama on February 17, 2009 Size of the Stimulus = $787billion (5.5% of GDP) Largest Fiscal Stimulus in US History

Y P AD 0 AS Y2Y2 Y0Y0 P0P0 The Worry if No Stimulus – AD Would Continue to Decline AD 2 P2P2 AD 3 Due to W and Tight Credit Worry if no Stimulus P3P3 Y3Y3

Y P AD 0 AS Y2Y2 Y0Y0 P0P0 Goal of the Stimulus – Shift AD 1 to the Right to AD 4 AD 2 P2P2 AD 4

Stimulus Package (Billions of Dollars) Government Spending Increases $260 (1/3) Tax Cuts $260 (1/3) Transfer Payment Increases $260 (1/3) Total $787

Real GDP Growth