Recession in Advanced Economies: A View from the United States Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth The return of Keynes Origins Onset of the crisis US Recession

Recession in Advanced Economies: A View from the United States Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth The return of Keynes Origins Onset of the crisis US Recession www.phwiki.com

Recession in Advanced Economies: A View from the United States Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth The return of Keynes Origins Onset of the crisis US Recession

Wayner, Peter, Contributing Editor has reference to this Academic Journal, PHwiki organized this Journal Recession in Advanced Economies: A View from the United States Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth The Bellagio Group Toronto, January 30, 2009 The return of Keynes Most economists still shy away from using the name. But Keynesian truths abound today: Origins of the crisis The Liquidity Trap Fiscal response Motivation as long as macroeconomic intervention: to save market microeconomics International transmission & coordination Origins The origin of the crisis was an asset bubble collapse, loss of confidence, credit crunch. More like Keynes’ animal spirits or beauty contest (or Minsky) than like Friedman-Schwarz (or monetary models of the last 3 decades). It was not a monetary cycle – contraction in response to inflation (as were 1980-82 or 1991). But, rather, a credit cycle: 2003-04 monetary expansion showed up in asset prices The BIS got this right (Claudio Borio ).

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Onset of the crisis Initial reaction to troubles: Reassurance in mid-2-7: “The subprime mortgage crisis is contained.” It wasn’t. Then, “The crisis may stay on Wall Street, sparing Main Street.” It didn’t. Then de-coupling : “The US turmoil will have less effect on the rest of the world than in the past.” It hasn’t. By now it is clear that the crisis-turned-recession is as bad abroad as in the US. US Recession In December 2008, the NBER Business Cycle Dating Committee proclaimed the US peak had occurred December 2007. Recovery unlikely be as long as e late 2009. Housing starts at record lows. Confidence at record lows => Recession is longest since 1930s. Could well be as severe as 1980-82.

US employment peaked in Dec. 2007, which is the most important reason why the NBER BCDC dated the peak from that month. Since then, 2 ½ million jobs have been lost. Payroll employment series Source: Bureau of Labor Statistics My favorite monthly indicator is total hours worked in the economy It confirms: US recession turned severe in September, when the worst of the financial crisis hit (Lehman bankruptcy ) Recession was soon transmitted to rest of world: Contagion: Falling securities markets & contracting credit. Especially in those countries with weak fundamentals: Icel in addition to , Hungary & Ukraine But even in some where fundamentals were relatively strong: Korea Some others are experiencing their own housing crashes: Irel in addition to , Spain Recession in big countries will be transmitted to all trading partners through loss of exports.

Housing bubble burst Housing permits falling almost everywhere OECD as long as ecasts showed its growth approx. flat in 2009 Source: OECD Economic Outlook (Nov. 2008).

Similarly, World Bank as long as ecasts showed rich-country growth flat in 2009. World 4.0 3.7 2.5 0.9 3.0 Memo item: World (PPP wts) 5.0 4.9 3.6 1.9 3.9 High-income countries 3.0 2.6 1.3 0.1 2.0 2006 2007 2008 2009† 2010† Developing countries 7.7 7.9 6.3 4.5 6.1 Estimated † Projected Source: World Bank, Jan. 2009 (% change from previous year) have now downgraded again (Jan.28, 09) All large countries in recession Bank of Japan now expects to contract (1/23/08): 1.8 % in year ending March 2008, in addition to 2% in the coming year. Eurol in addition to ’s recession looks worse UK ditto: Sir John Gieve (BoE Dep.Gov. 1/16/09) predicted another steep fall in GDP in Q1 2009, following a decline in the last Q of 2008. Euro. Comm. : EU growth = -1.8% in 2009. (19 Jan.,09) Bank of Canada as long as ecasts -2.3% growth, 08 Q4; followed by – 4.8 % as long as 09 Q1 in addition to -1 % as long as Q2 (1/22/09 update to Monetary Policy Report). China growth rate probably down by half.

Unemployment is rising US € Japan Policy Responses Monetary easing unprecedented, appropriately. But it has largely run its course: Policy interest rates 0. (graph) The famous liquidity trip is not mythical after all. As Krugman & others warned us in re Japan in 90s. & lending, even inter-bank, builds in big spreads since mid-2007, not just since September 2008. (graph) Now quantitative easing, as the Fed continues to purchase assets not previously dreamt of. Policy rates have been cut most of the way to zero. US € Japan

Bank spreads up when sub-prime mortgage crisis hit (Aug. 2007) in addition to up again when Lehman crisis hit (Sept. 2008). Source: OECD Economic Outlook (Nov. 2008). Corporate spreads between corporate & government benchmark bonds zoomed after Sept. 2008 US € Policy Responses, continued Likely Obama policy of “financial repair”: Infusion of funds will be more conditional, Vs. Bush Administration’s no-strings-attached. Some money goes to reduce as long as eclosures. I’d consider imposing on banks that want help: (1) no-dividends rule, (2) more serious curbs on executive pay, & (3) no takeovers, unless at request of authorities

Policy Responses, continued The TARP keeps evolving First unspecific, then to buy toxic loans, then to recapitalize banks, then auto bailout, Now up in the air: insure banks’ toxic assets rather than acquire them create “bad bank” as in “Swedish model” outright nationalization not yet under consideration in US. Policy Responses, continued Unprecedented US fiscal expansion, most of which is still to come. Obama proposed an $825 expansion House passed a version. Senate will soon. Good old-fashioned Keynesian stimulus Even the belief that spending provides more stimulus than tax cuts has returned not just from Larry Summers, as long as example, but also from Martin Feldstein. “Timely, targeted in addition to temporary.” American Recovery & Reinvestment Plan includes: Aid to states: education, Medicaid ; Other spending. Unemployment benefits, food stamps, especially infrastructure, in addition to Computerizing medical records, smarter electricity distribution grids, in addition to high-speed Internet access. Tax cuts (un as long as tunately still distorted by politics) Cut as long as lower-income workers EITC, child tax credit, payroll tax holiday. Other (less well-targeted) tax cuts dem in addition to ed by Congressional Republicans Hopefully a fix as long as the AMT.

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Motivation as long as macroeconomic intervention The view that Keynes stood as long as big government is not really right. He wanted to save market microeconomics from central planning, which had allure in the 30s & 40s. Some on the Left today reacted to the crisis & Obama’s election by hoping as long as a new New Deal. My view: faith in unfettered capitalist system has been shaken with respect to financial markets, true; but not with respect to the rest of the economy; Obama’s economics will be centrist, not far left. International transmission As noted, international transmission remains powerful Despite floating exchange rates Consistent with old-fashioned Keynes-Meade-Mundell-Fleming transmission via trade balances. Global Current Account Imbalances will probably now be as long as ced to adjust US deficit will likely diminish, though adjustment requires $ depreciation. Who must take corresponding reduction in current account surpluses Europe says: “Not us. Overall we are in balance.” Others say: Europe can expect to take a share, roughly proportionate to its share in world trade, especially in light of strong €, regardless starting position of CA. IMF seems to think oil exporters will take all adjustment (see graph)

Current account adjustment: US vis-á-vis oil exporters (as % of GWP; source: IMF) But the OECD sees the €-area bearing almost as much of the adjustment as non-OECD countries. Source: OECD Economic Outlook, Nov. 2008. 3/ as % of GDP Fiscal expansion internationally EU agreed 1.5% GDP expansion in Dec. More coming Most other countries as well China Is the most obvious c in addition to idate as long as fiscal expansion. What PRC has announced is less than it sounded. Fiscal expansion & development of health care, pensions, etc., would be a more productive topic as long as international discussion than RMB “manipulation”.

International coordination of fiscal expansion As in the classic Locomotive Theory Theory: in the Nash non-cooperative equilibrium each country fears exp in addition to ing fiscally as long as fear of adverse trade deficit. Solution: A bargain where all exp in addition to together. In practice: example of Bonn Summit, 1978 didn’t turn out so well, primarily because inflation turned out to be a bigger problem than realized (& German world was non-Keynesian). That is less likely to be a problem this time.

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