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LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS FROM ASSET BUBBLES TO A LIQUIDITY TRAP Presented by A.G. Malliaris A Conference on the Global Financial.

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Presentation on theme: "LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS FROM ASSET BUBBLES TO A LIQUIDITY TRAP Presented by A.G. Malliaris A Conference on the Global Financial."— Presentation transcript:

1 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS FROM ASSET BUBBLES TO A LIQUIDITY TRAP Presented by A.G. Malliaris A Conference on the Global Financial Crisis of 2007-09 April 11, 2013

2 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS PURPOSE OF PRESENTATION Consider the Cyclical Behavior of the U.S. Economy Distinguish 4 Phases: Expansion, Upper Turning, Recession and Lower Turning Focus on the Global Financial Crisis of 2007- 09 Introduce Behavioral Hypotheses

3 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

4 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

5 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

6 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

7 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

8 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

9 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

10 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

11 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS “We can model the euphoria and the fear stages of the business cycle. Their parameters are quite different. We have never successfully modeled the transition from euphoria to fear” Alan Greenspan

12 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS CHALLENGE Decompose an economic cycle into 4 phases instead of just 2 Introduce Upper Turning Period and Lower Turning Period

13 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS Expansion Recession

14 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS Upper Turning Period Expansion Recession Lower Turning Period

15 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS METHODOLOGY Use Current Economic Reasoning Introduce Ideas from Behavioral Finance Reconsider Keynes’s “Animal Spirits” Employ Minsky’s Financial Instability Hypothesis Apply This Methodology to the Latest Global Financial Crisis

16 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS The Expansion Phase: December 2001 to November 2007 The expansion was weaker than average One major event: the formation of the Housing Bubble

17 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

18 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

19 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

20 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

21 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

22 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS “The dogmas of the quiet past are inadequate to the stormy present” Abraham Lincoln

23 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS Asset Price Bubbles Interplay Between Economic and Behavioral Factors Economic Factors: Easy Monetary Policy; Global Imbalances; Financial Innovations; Poor Incentives and Regulation Behavioral Factors: Representative Heuristic, Feedback Mechanism, Overconfidence, Short Selling Constraints

24 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS Upper Turning Period: January 2007 to September 2008 Concave, Fragile and Ambivalent Housing Prices Peak by Mid-2006 and then Begin to Decline Behavioral Finance: Prospect Theory From a Subprime Crisis to a Full Credit Crisis Lehman’ s Bankruptcy Financial and Psychological Amplification Minsky’s Instability Hypothesis

25 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS The Great Recession

26 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS Job Losses Were Unprecedented

27 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

28 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS The Lower Turning Period: The Liquidity Trap When Interest Rates Are Close to Zero While the Economy is Below Its Potential and Has High Unemployment Period of Economic and Psychological Uncertainty Aggressive Monetary Policy: Q1, Q2, Q3 Indecisive Fiscal Policy

29 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS GDP Fell Far Below What the Economy Was Capable of Producing

30 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

31 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die. Keynes 1936

32 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

33 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

34 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS Legislative Response

35 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

36 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS Financial Stability Oversight Council Established by under the Dodd-Frank Wall Street Reform and Consumer Protection Act Restore Optimism in Long-run Economic Expectations Reconsider Price Stability, Financial Stability and Global Economic Stability Reassess Debt-Financed Government Spending Support Growth that Generates Employment

37 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESSLOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS “It is better to act and repent than not to act and regret it” Machiavelli

38 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS THANK YOU

39 LOYOLA UNIVERSITY CHICAGOQUINLAN SCHOOL OF BUSINESS

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