There is an old joke among economists that states:

A Recess ion i s when your ne ighbour loses h is job. A depress ion i s when you lose your job.

Presentation On Recession In Japan & United States

• Guided By: Prof. Sujata Jhamb

Submitted By: Gaurav Surana

Anshul Aggarwal Anuj Karwa Rahul Goyal Rahul Rathi

Outline• Business Cycle• What causes to recession?• History Of Recessions• How Fiscal & Monetary policy affect

economy?• US Recession• Macro Economic Measures and its impact in

USA• Japanese Bubble• Macro Economic Measures and its impact in

Japan• Comparison• Japanese Mystery

Business Cycle• The business cycle is the periodic but irregular up-and-down

movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables

• A business cycle is identified as a sequence of four phases: – Contraction (A slowdown in the pace of economic activity) – Trough (The lower turning point of a business cycle, where a

contraction turns into an expansion) – Expansion (A speedup in the pace of economic activity) – Peak (The upper turning of a business cycle)

• A recession occurs if a contraction is severe enough... A deep trough is called a slump or a depression.

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What is Recession ?• A recession is a contraction phase of the business cycle.• The official agency in charge of declaring that the economy is in a

state of recession is the National Bureau of Economic Research (NBER).

They define recession as a "significant decline in economic activity lasting more than a few months“, which is normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

• For this reason, the official designation of recession may not come until after we are in a recession for six months or even longer

• Some economists also suggest that a recession occurs when the natural growth rate in GDP is less than the average of 2%. Typically, a normal economic recession lasts for approximately 1 year.

Contraction Period

What Causes Recession ?

• An economy which grows over a period of time tends to slow down the growth as a part of the normal economic cycle.

• An economy typically expands for 6-10 years and tends to go into a recession for about six months to 2 years.

• A recession normally takes place when consumers lose confidence in the growth of the economy and spend less.

• This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment.

• Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment.

History of Recession Name Date Durati

onCauses

Panic of 1907

1907–1908

1 year A run on knickerbocker Trust Company deposits on October 22,1907 set events in motion that would lead to a severe monetary contraction.

Post World War I Recession

1918–1921

3 years

Severe Hyperinflation in Europe took place over production in North America. It was a brief but very sharp recession and was caused by the end of wartime production, along with an influx of labor from returning troops. This in turn caused high unemployment.

Great Depression

1929–1939

10 years

Stock markets crashed worldwide, and a banking collapse took place in the United States. This sparked a global downturn, including a second, more minor recession in the United States, the Recession of 1937.

Recession of 1953

1953–1954 1 year

After a post-Korean War inflationary period, more funds were transferred into national security. The Federal Reserve changed monetary policy to be more restrictive in 1952 due to fears of further inflation.

Recession of 1957

1957–1958 1 year

Monetary policy was tightened during the two years preceding 1957, followed by an easing of policy at the end of 1957. The budget balance resulted in a change in budget surplus of 0.8% of GDP in 1957 to a budget deficit of 0.6% of GDP in 1958, and then to 2.6% of GDP in 1959.

1973 oil crisis

1973–1975

2 years

A quadrupling of oil prices by OPEC coupled with high government spending due to the Vietnam War led to stagflation in the United States.

Early 1980s recession

1980–1982

2 years

The Iranian Revolution sharply increased the price of oil around the world in 1979, causing the 1979 energy crisis. This was caused by the new regime in power in Iran, which exported oil at inconsistent intervals and at a lower volume, forcing prices to go up. Tight monetary policy in the United States to control inflation led to another recession. The changes were made largely because of inflation that was carried over from the previous decade due to the 1973 oil crisis and the 1979 energy crisis.

History of Recession

Early 2000s recession

2001–2003

2 years

The collapse of the dot-com bubble, the September 11th attacks, and accounting scandals contributed to a relatively mild contraction in the North American economy.

2008 2008– – The Subprime mortgage crisis.

Early 1990s recession

1990–1991 1 year Industrial production and manufacturing-trade sales decreased

in early 1991.

History of Recession

Recession Or Not ?

• According to numbers published by Bureau of Economic Analysis in May 2008, the GDP growth of the previous two quarters was positive. As one common definition of a recession is negative economic growth for at least two consecutive fiscal quarters, some analysts suggest this indicates that the U.S. economy was not in a recession at the time

• However this estimate has been disputed by some analysts who argue that if inflation is taken into account, the GDP growth was negative for the past two quarters, making it a technical recession

Causes Of US Recession

• The general consensus is that a recession is primarily caused by the actions taken to control the money supply in the economy and fall in aggregate demand which is not supplemented by price adjustments

• The Federal Reserve is responsible for maintaining an ideal balance between money supply, interest rates, and inflation

• When the Fed loses balance in this equation, the economy can spiral out of control, forcing it to correct itself

• Relaxed policies in lending practices making it easy to borrow money.The economic activity became unsustainable resulting in the economy coming to a near halt

• Recession can also be caused by factors like : Supply Shock - Natural Disasters, Sharp change in exchange rates,

War Demand Shock – Energy price changes

How Fiscal & Monetary Policy Affect the Economy

• Monetary Policy : Expansionary Monetary policy helps lower interest rates, boosting investment spending and interest sensitive consumer spending.It also lowers the international exchange value of currency which also boosts exports and imports

• Fiscal Policy : Expansion of budget deficit also boosts aggregate spending. Undertaken through higher govt. spending, tax cuts etc.

U S Recession

Stagflation Recession – 1970’s• Primarily remembered for simultaneous rise in both inflation and

unemployment rate. Reasons : Rise in oil prices from $2.6/barrel to $11/barrel which lead to rise in

inflation. To counter this Fed Reserve increased fund rates from 5% to 10%. Also, it was preceded by poor performance of the 1970’s. Measures : To counter recession expansionary Monetary and fiscal policy was adopted. Fund rate cuts from as high as 13% to 5.25% was also implemented. Huge tax rebate, individual income tax credits and deductions, reduced

corporate tax. Tax cuts and others lowered revenues by 1.4% of GDP in 1975.

Stagflation Recession – 1970’s

Recession – 1980’s• It was one of the deepest & longest recession of the post war

period Reasons :

In attempt to reduce the inflation which was 11.1% Fed Reserve decided to increase fund rate from 10.5% to 17.5 and finally to as high as 19%.

Secondly, due to Iranian revolution oil prices rose from $13/barrel to $37/barrel

Measures : A tight monetary policy was accompanied by expansionary Fiscal policy to boost on public confidence – Reduction in

marginal tax rates and individual saving incentives. Followed by a bit correction in oil prices and real interest rates

Recession – 1980’s

Dot Com Collapse• Different of all recession till now which had unexpected

reasons. Reasons : Dot com bubble Terrorist attack – resulting in undermined public confidence

which leads fall in spending and thus fall in aggregate demand GDP which grew at average 4% in mid 90’s fall to 1.1% in 2001 Unemployment Rate rose from 3.9% to 5.8% Measures : Fed Rate Cut from 6.5% to 1.75% Fiscal expansions were also used like tax cuts and fiscal

stimulus which was equal to around 1% of GDP

Crisis In The US

• The United States entered 2008 during a housing market correction, a subprime mortgage crisis and a declining dollar value

• In February, 63,000 jobs were lost, a 5-year record.• In September, 159,000 jobs were lost, bringing the monthly average

to 84,000 per month from January to September of 2008• On September 5, 2008, the United States Department of Labor issued

a report that its unemployment rate rose to 6.1%, the highest in five years

• The defaults on sub-prime mortgages (homeloan defaults) have led to a major crisis in the US

• Sub-prime is a high risk debt offered to people with poor credit worthiness or unstable incomes. Major banks have landed in trouble after people could not pay back loans

• The housing market soared on the back of easy availability of loans• The realty sector boomed but could not sustain the momentum for

long, and it collapsed under the gargantuan weight of crippling loan defaults

• Foreclosures spread like wildfire putting the US economy on shaky ground. This, coupled with rising oil prices at $100 a barrel, slowed down the growth of the economy

Crisis in the US

Liquidity Crisis

• In early July, depositors at the Los Angeles offices of IndyMac Bank frantically lined up in the street to withdraw their money.

• On July 11, IndyMac - the largest mortgage lender in the US – was seized by federal regulators.

• The mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures

• During the weekend of September13–14, Lehman Brothers declared bankruptcy after failing to find a buyer

• Bank of America agreed to purchase Merrill Lynch, the insurance company AIG sought a bridge loan from the Federal Reserve

• And a consortium of 10 banks created an emergency fund of at least $70 billion to deal with the effects of Lehman's closure

Liquidity Crisis• The biggest bank failure in history occurred on September 25 when JP

Morgan Chase agreed to purchase the banking assets of Washington Mutual• The year 2008 as of September 17 has seen 81 public corporations file for

bankruptcy in the United States, already higher than the 78 in 2007• Lehman Brothers being the largest bankruptcy in U.S. history also makes

2008 a record year in terms of assets with Lehman's $691 billion in assets all past annual totals

• The year also saw the ninth biggest bankruptcy with the failure of IndyMac Bank

• On September 29, Citigroup beat out Wells Fargo to acquire the ailing Wachovia's assets will pay $1 a share, or about $2.2 billion

• In addition, the FDIC said that the agency would absorb the company‘s losses above $42 billion; in exchange they would receive $12 billion in preferred stock and warrants from Citigroup in return for assuming that risk

Measures to TackleRecession

• Tax cuts are the first step that a government fighting recessionary trends or a full-fledged recession proposes to do. Fed Reserve has Fund rates from 6% to 1% now.

• The government also hikes its spending to create more jobs and boost the manufacturing and services sectors and to prop up the economy.

• The government also takes steps to help the private sector come out of the crisis

• In the current case, the Bush government has proposed a bailout, of the cost of the Treasury of $700 billion U.S. dollars

• Other Fiscal policy measures and stimulus proposed.

Japanese Recession

The Japanese Story• The robust growth that Japan had experienced since the end of World War

II came to an end when Japan`s bubble economy collapsed at the beginning of the 1990s

• In 1989 the Bank of Japan changed to a tight-money policy• 1990 the Ministry of Finance requested banks restrict their financing of

property assets• New land taxation laws (landholding tax)• Financial institutions suffered from nonperforming loans• Companies` three excesses: – Excess capital investment – Excess employment – Excessive debt• Deflationary spiral and higher unemployment• This period is often called the “Lost Decade“

The Lost Decade 1991 – 1995:• Asset deflation• Reversed wealth effect : “Vicious cycle” 1995 – 1996:• Yen Appreciation• Massive fiscal expansion 1997 – 1999:• Fiscal contraction• Banking crisis 1999 – onwards:• Deflation, Liquidity trap• Social security system crisis

Vicious Cycle

The Slump

0.43.41.81997

0.83.43.51996

1.44.10.81999

0.13.41.11998

1.65.00.72001

1.64.71.52000

0.43.11.61995

1.72.20.919920.62.50.419930.12.91.01994

3.02.4

Inflation Rate (%)

Output Growth, Unemployment, and Inflation, Japan 1990-2001

2.13.11991

2.15.31990

Unemployment Rate (%)Output Growth Rate (%)Year

Japan Price Level

The Rise and Fall of the Nikkei• There are two reasons for the increase in a stock

price:1. A change in the fundamental value of the stock price,

which depends on the expected present value of future dividends.

2. A speculative bubble: Investors buy at a higher price simply because they expect the price to go even higher in the future.

The Rise and Fall of the Nikkei

Stock Prices and Dividends, Japan, 1980-2001The increase in stock prices in the 1980s and the subsequent decrease have not been associated with a parallel movement in dividends.

The Rise and Fall of the Nikkei• The fact that dividends remained flat while stock

prices increased strongly suggests that a large bubble existed in the Nikkei.

• The rapid fall in stock prices had a major impact on spending—consumption was less affected, but investment collapsed.

The Rise and Fall of the Nikkei

GDP, Consumption, and Investment Growth, Japan, 1988-1993

YearGDP(%)

Consumption (%)

Investment(%)

1988 6.5 5.1 15.5

1989 5.3 4.7 15.0

1990 5.3 4.4 11.5

1991 3.1 2.1 4.4

1992 0.9 2.2 7.3

1993 0.4 2.5 11.6

The Failure of Monetaryand Fiscal Policy

• Monetary policy was used, but it was used too late, and when it was used, it faced the twin problems of the liquidity trap and deflation.

• The Bank of Japan (BoJ) cut the nominal interest rate, but it did so slowly, and the cumulative effect of low growth was such that inflation had turned to deflation. As a result, the real interest rate was higher than the nominal interest rate.

The Failure of Monetaryand Fiscal Policy

The Nominal Interest Rate and the Real Interest Rate in Japan, 1990-2001

Japan is now in a liquidity trap: The nominal interest rate is close to zero. Deflation implies that even at a zero nominal interest rate, the real interest rate is positive.

The Failure of Monetaryand Fiscal Policy

• Fiscal policy was used as well. Taxes decreased at the start of the slump, and there was a steady increase in government spending throughout the decade.

• Fiscal policy helped, but it was not enough to increase spending and output.

The Failure of Monetaryand Fiscal Policy

Government revenues and spending in Japan, 1990-2001Fiscal policy limited the decline, but did not lead to a recovery. In the absence of increased government spending, output would have declined even more.

Why Didn’t Macro Policy work• Tax CutsNo one to give tax cuts: 60% of the total tax payers were not paying taxes

after series of tax cuts -- To high minimum taxable income• Monetary Policy Not effective especially in late 90’s -- “Liquidity Trap” -- Banking Crisis in 1997-98

What Comes Next?• Policy recommendations for the Japanese economy

include:– Create inflation: More inflation is good because the real

interest rate would decrease, thereby stimulating spending and output.

– Clean up the banking system: Too many bad firms continue to be financed by the banks, thereby preventing the good firms from obtaining financing at reasonable terms.

Comparison

House prices nationwide rose by 51%

Commercial property average prices rose by (80%)

JapanHouse prices nationwide rose by 90%

Commercial property average prices rose by (90%)

US

Comparison• Japan also had a stock market bubble, which burst a year earlier

than that in property. This hurt banks, because they counted part of their equity holdings in other firms as capital. But its impact on households was modest, because only 30% of the population held shares, compared with over half of Americans

• The Bank of Japan (BoJ) began to lower interest rates in July 1991, soon after property prices began to decline. The discount rate was cut from 6% to 1.75% by the end of 1993. Two years after American house prices started to slide, the Fed funds rate has fallen from 5.25% to 2%

• Japan also gave its economy a big fiscal boost. Similar to America’s budget boost this year

• But deflation also emerged in 1995, pushing up real interest rates and increasing the real burden of debt

GDP Growth Rates

Comparison• America’s inflation rate of above 5% is an

advantage. Not only are real interest rates negative, but inflation is also helping to bring the housing market back to fair value with a smaller fall in prices than otherwise

• But in another way America is more exposed than Japan was. When its bubble burst in 1991, Japan’s households saved 15% of their income. By 2001 saving had fallen to 5%, which helped to prop up consumer spending. America’s saving rate of close to zero leaves no such cushion.

Comparison• America is spreading the costs of its housing bust

across other countries. Foreigners hold a large slice of American mortgage-backed securities. Sovereign-wealth funds have provided new capital for American banks. And America’s booming exports have helped to support its economy, thanks to the cheap dollar. In contrast, the yen’s sharp appreciation after Japan’s bubble burst hurt exports at the same time as domestic demand was being squeezed.

Japanese Mystery !!!• Monetary and fiscal relief were necessary but not sufficient to revive Japan’s

economy• The missing ingredient was a clean-up of the banking system. Japanese

banks hid their bad loans beneath opaque corporate structures, and curtailed new lending to profitable businesses. A vicious circle developed, whereby banks bad loans depressed growth which then created more bad loans.

• In Japan it took a long while before the political will was there to use taxpayers’ money to plug the banking system

• The Expenditure by the Japanese govt. in public works, regional infrastructure projects, was of little help because relatively little of the money spent reached those who have been made unemployed.

• And the massive outlay means government borrowing has reached 180% of GDP, higher than any other industrialised country.

Bad Loans Are Bad !

Questions ???