Financial Crisis-cum-Great Recession Introduction to Financial Crisis-cum-Great Recession Vaughan / Economics 639 Fall 2015

Economy did not return to pre-1929 trend until 1941 Great Contraction* Length: 43 months* Industrial production: ↓51.7%* Rise in unemployment: ↑19.3 percentage points 1929 average to 1932 average Consumer prices: ↓27.2%* Bank failures: ≈ 9,000 37% of U.S. banks in December 1929 Stock prices (DJIA): ↓89.2% From market peak (9/3/29) to trough (7/8/32) * Indicator measured from cyclical peak in August 1929 to cyclical trough in March 1933. Economy did not return to pre-1929 trend until 1941

Long-Time to Recover to Trend Great Contraction Deep, Recovery Interrupted

Worst since World War II, but not even close to Great Contraction! Great Recession* Length: 18 months* Industrial production: ↓14.9%* Rise in unemployment: ↑5.7 percentage points From May 2007 to October 2009 (peak) Consumer prices: ↑1.5%* Bank failures: 501 Since Bear Stearns crisis (3/16/08), 5.9% of U.S. banks in March 2008 Stock prices (DJIA): ↓53.8% From market peak (10/9/07) to market trough (3/9/09) * Indicator measured from cyclical peak in December 2007 to cyclical trough in June 2009. Worst since World War II, but not even close to Great Contraction!

And Yet… The Recovery Remains Sluggish Why?

Financial Crisis-cum-Great Recession The Issues Was FC-c-GR foreseeable/different? U.S. data in “run up” similar to prior financial crises (Reinhart/Rogoff, 2008). Throughout post-WWII era, housing has (almost) always driven business cycle (Leamer). Data suggest “usual suspects” explain Great Recession, shocks just larger (Stock Watson). But, what is really different about GR is behavior of labor input/productivity (Ohanian). Not clear how financial crisis explains this.

Great Recession The Issues What caused housing bubble? Greed (?????) MDV Aside: Greed explains FC-c-GR no more than gravity explains plane crashes! “Greenspan Put” Moral hazard from perception government would bear downside of risks (Russell) Changes in policies promoting home ownership 1997 change in capital-gains exclusion Political/market pressure on Fannie /Freddie Weak regulation of bank capital (Kling) Basel risk weights 2002 change in weights for AAA/AA securities Monetary policy kept interest rates “too low” (Taylor 2009) World-wide savings glut (Bernanke 2005)

Financial Crisis-cum-Great Recession The Issues How important was bursting of housing bubble/ensuing financial crisis to depth of subsequent recession? What specific “triggers” / “vulnerabilities” made FC-c-GR possible? (Bernanke 2010) How did financial crisis unfold? (Gorton-Metrick) Key role “shadow” banking system Would “better” regulation have helped? Did overly “tight” monetary policy make things much worse? Yes (Sumner, Beckworth) No (Bernanke 2010)

Financial Crisis-cum-Great Recession The Issues Why has recovery been historically weak? Just life after financial crisis (Reinhart/Rogoff 2012) Bad luck Demographics (Stock/Watson) Slowdown in innovation (Cowen) Anemic bank lending (Bernanke 1983, Kwan)

Financial Crisis-cum-Great Recession The Issues Why has recovery been historically weak? Just life after financial crisis (Reinhart/Rogoff 2012) Bad luck Demographics (Stock/Watson) Slowdown in innovation (Cowen) Anemic bank lending (Bernanke 1983, Kwan) Bad policy responses Acts of omission Insufficient fiscal stimulus (Pro - Krugman, Con - Ramey/Zubairy) Insufficient monetary stimulus Lack of pro start-up/productivity policies (Prescott/Ohanian) Acts of commission Obamacare (Mulligan) Dodd-Frank (Wallison) Miscellaneous other policy responses (Taylor 2010) Policy Uncertainty (Baker, Bloom, and Davis)

Financial Crisis-cum-Great Recession Questions?? Introduction to Financial Crisis-cum-Great Recession Vaughan / Economics 639 Fall 2015

Banks not ready to lend, either… Particularly after a financial crisis!