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

2. 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 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

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

4. 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: Since Bear Stearns crisis (3/16/08), % 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!

5. And Yet… The Recovery Remains Sluggish
Why?

6. 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.

7. 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)

8. 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)

9. 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)

10. 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)

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

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