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L f h Fi i l C i i fLessonsfromtheFinancialCrisisforTeachingEconomicsg
John B TaylorJohnB.TaylorStanfordUniversity
June2,2011
NationalConferenceonTeachingEconomicsandResearchinEconomicEducation
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OutlineOutline NarrativeoftheFinancialCrisis
Informsonesviewsaboutlessonsforteaching AlternativeNarratives
N t i i l i t di Notsurprisingly,economistsdisagree ImplicationsforTeaching
Examples will be presented throughout talk based on Exampleswillbepresentedthroughouttalkbasedonexperience
Graduate(1styearPh.D.courseatStanford) Undergraduate(Economics1atStanford) Textbook(PrinciplesBookwithWeerapana)
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NarrativeE i li d i t d f b i i Economicpolicydeviatedfrombasiceconomicprincipleswhichhadworkedwell
Result? A great recession a financial panic and a Result?Agreatrecession,afinancialpanic,andaveryweak,nearlynonexistent,recovery.
The deviations began with policies such asThedeviationsbeganwithpoliciessuchas amonetarypolicywithinterestratestoolowfortoolong aregulatorypolicywhichfailedtoenforceexistingrulesg y p y g
Thedeviationsfromsoundprinciplescontinuedwhengovernmentrespondedwithanadhocbailoutprocessandtemporarystimulusprograms
Thegoodnews:economicgrowthandstabilitycanberestoredbyadoptingpoliciesconsistentwithbasiceconomicprinciples.
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Anillustrationthatbasicprinciplesworkwell,whenfollowed
15
20Percent
GreatModerationperiod
10
15 period
0
5
-5
0
G t R i
-15
-10GreatRecession(EndofGreatModeration?)
50 55 60 65 70 75 80 85 90 95 00 05 10
Growth Rate of Real GDP
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IllustrativemonetarypolicychartfromSanFranciscoFed,March1995,JuddandTrehan
196579
198792
199394
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IllustrativemonetarypolicychartfromStLouisFedFebruary2007,BillPooley
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PolicyDeviationsLeadinguptothed h llCrisisandthePanicinFall2008
Interestratestoolowfortoolongg DiscretionaryfiscalstimulusofFeb08($152B) Onagain offagain bailouts financed by centralOnagain,offagainbailoutsfinancedbycentralbanksbalancesheet on for BSC creditors bailout off for Lehman creditorson forBSCcreditors bailout,off forLehmancreditors bailout,on forAIGcreditorsbailout,off forTARProleout
Government regulators and supervisors deviatedGovernmentregulatorsandsupervisorsdeviatedfromsoundregulatoryrules,especiallyatlargebanks
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IllustrativemonetarypolicychartfromStLouisFedFebruary2007,BillPooley
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IllustrativemonetarypolicychartfromStLouisFedFebruary2007,BillPooley
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ChartfromKansasCityFed,2009,TomHoenig
(20002009)
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TheBoomBustinHousingStartsCompared with the CounterfactualComparedwiththeCounterfactual
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IllustrativeChartfromtheOECD,March2008
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IllustrativeChartfromtheOECD,March2008
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Temporarystimulusmeetspermanentincomehypothesisp yp
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ThePanicofFall08
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Policy makers then doubleddownPolicymakersthendoubled down
Discretionaryfiscalstimulusof2009($862billion)sc et o a y sca st u us o 009 ($86 b o ) Onetimepaymentsagain Moregovernmentspendingtoo
Cashforclunkersprogram Quantitativeeasingin2009,nowcalledQE1
Purchasesof$1.25trillionofmortgagebackedsecurities,$300billionoflongertermTreasurybonds
QE2 i 2010 d 2011 QE2in2010and2011 purchasesof$600billionoflongertermTreasurybondsbonds.
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Temporarystimulusmeetspermanentincomehypothesisagainp yp g
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Cashforclunkers:incentivesreallymatter
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400Billions of dollars, annual rates
300
350
200
250 --- Temporary transfer payments and credits
t
150
200
G t t t t d
to persons
50
100
F d l t ti
--- Grants to state and local governments
009Q1 09Q2 09Q3 09Q4 10Q1 10Q2 10Q3 10Q4
--- Federal government investment--- Federal government consumption
Two-Year Effect of ARRA on Major Federal Budget Categories (Source: Bureau of Economic Analysis)
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2,300Billions of dollars, annual rates
2 100
2,200
,Total receipts of stateand local governments
2,000
2,100
Recepits less
1,800
1,900p
ARRA grants
1 600
1,700 Purchases by state and local governments
1,500
1,600
1,4002005 2006 2007 2008 2009 2010
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Stateandlocalgovernmentsalsoconsiderpermanentincome
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Comparewithtextbookdiscussion:Sharp drop in I causes expenditure lineSharpdropinIcausesexpenditureline
toshiftdown
45-degree line
SPENDING25_10
New E line
Original E lineOriginal point of spending balance
I falls by this amount
Income or real GDP falls by this amount (more than by amount I falls ).
New point of spending balance
Original income level
New income level
INCOME OR REAL GDP
(more than by amount I falls ).
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OffsetbyCountercyclicalfiscalpolicyIncreaseinGraisesGDPdependingonsizeofthep g
multiplierandamountofcrowdingout
45-degree line
SPENDING25_10
G rises
INCOME OR REAL GDP
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Butlookwhathappened
6Percent, annual rate
Growth rate of real GDP
2
4
0Contribution of
-4
-2 government purchases
-6
-807Q1 07Q3 08Q1 08Q3 09Q1 09Q3 10Q1 10Q3
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QuantitativeEasingFinancedbyMonetaryBase
2,800Billions of dollars
2,400Monetarybase(currencyplusreserves)
2,000
1,600
1,200
800Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11
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AWonderfulTeachingMoment:The Money Multiplier and the Monetary BaseTheMoneyMultiplierandtheMonetaryBase
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Percent
800
1,000CBO Outlook in 2010
600
800
Federal Debt as a
CBO Outlook in 2009
400
600 Federal Debt as aPercent of GDP
200
400
0
200
CBO Outlook in 2011??0
1800 1850 1900 1950 2000 2050
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TeachingAboutRegulatoryCapture:E l i f il t f l t lExplainsfailuretoenforceregulatoryrules
C ti b t Cozyconnectionsbetweengovernmentandthefi i l i d tfinancialindustry.
Bookshowsgovernmenthelpingwellconnectedindividuals,whointurnhelpedthegovernmentofficials.
Result:Recklesspolicy
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ImplicationofNarrativeforBasicEconomics
Needsareformulation? PaulSamuelson(January2009)PaulSamuelson(January2009)
todayweseehowutterlymistakenwastheMiltonFriedmannotionthatamarketsystemcanregulateitselfThisprevailing ideology of the last few decades has now beenprevailingideologyofthelastfewdecadeshasnowbeenreversedIwishFriedmanwerestillalivesohecouldwitnesshowhisextremismledtothedefeatofhisownideas.
PaulKrugman blamesmoderneconomics(especiallymacro)forthecrisis.
B t ti h i li b i i k Butnarrativehereimpliesbasiceconomicsworks Thecrisiswascausedbyadeviationfromprinciples
f h h h d Butofcoursethereismuchresearchtodo
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Another NarrativeAnotherNarrative
US policy was not an issue leading up to theUSpolicywasnotanissueleadinguptothecrisisandisnotanissuenow
Global capital flows were and are the problem Globalcapitalflowswereandaretheproblem Causedemergingmarketcrisesin1990sC d 2007 09 i i S i Gl Caused200709crisis:SavingGlut
Causeoffuturecrises:focusonglobalrebalancing Muchdifferentpolicyimplication
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ButchartfromtheIMFin2005ShowsNoGlobalSavingGlut
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So Why Do Economists Disagree?SoWhyDoEconomistsDisagree?
Students and everyone else really want toStudentsandeveryoneelsereallywanttoknowtheanswer
One reason is that the details of their models Onereasonisthatthedetailsoftheirmodelsaredifferent,eventhoughthereisagreementabout the basic principlesaboutthebasicprinciples
ThenextthreechartsfromtheNewYorkTi d h ill hi llTimes andtwoothersillustratethiswell.
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66
NewKeynesianSmets ECB
RobertBarroHarvard
3
4
5With stimulus
3
4
5
With stimulus
0
1
2If nostimulus
0
1
2If nostimulus
-12009 2010
-12009 2010
The accumulation of hard data and real-lifeThe accumulation of hard data and real life experience has allowed more dispassionate analysts to reach a consensus that the stimulus package, messy p g yas it is, is workingNew York Times November 12, 2009
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ImplicationsforTeachingM ill t ti f b i i Manynewillustrationsofbasiceconomics
InterestingdebatesbetweeneconomistsR l di ti Rulesversusdiscretion
Butraisemorequestionsaboutdiscretionarypolicy More integration of micro and macro Moreintegrationofmicroandmacro
interestratestoolowfortoolong(macro) housing markets including bubbles (micro)housingmarketsincludingbubbles(micro) stimuluspackage(macro) regulatorycaptureandmoralhazard(micro) newinstrumentsofmonetarypolicy(macro) riskpremia ininterestrates(micro) debateoversizeofmultipliers(macro) cashforclunkers,firsttimehomebuyer(micro)
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ManyNewYouTubeVideosQuantitativeEasingExplained.5milliondownloads.Doesn't
getitallrightandbrutalinplaces,butgoodfordiscussionTheWrongFinancialAdviser CreatedbyNobelprizewinner
BillSharpeFedChairmanontheDailyShowwithJonStewart.Fromtwo
differentepisodesof60Minutes,focusonwhetherquantitativeeasingisprintingmoney.
UnmaskingInterestRates,HonkyTonk StyleMerleHazardsings"InflationorDeflationInsideJobTrailerChristine Lagarde in clip from Inside JobChristineLagarde inclipfromInsideJobHayekKeynesrapvideos"FeartheBoomandBustandFight
oftheCentury
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Lines from Fight of the CenturyLinesfrom FightoftheCentury
Keynes: Even you must admit that the lessonKeynes: Evenyoumustadmitthatthelessonwevelearnedisthatmoreoversightsneededor else well get burnedorelsewe llgetburned
Hayek:Oversight?Thegovernmentslongbeenin bed with those Wall Street execs and theinbedwiththoseWallStreetexecsandthefirmsthattheyveled.