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Aggregate Demand II: Applying the IS-LM Model Chapter 12 of Macroeconomics, 8 th edition, by N. Gregory MankiwMacroeconomics ECO62ECO62 Udayan RoyUdayan.

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Presentation on theme: "Aggregate Demand II: Applying the IS-LM Model Chapter 12 of Macroeconomics, 8 th edition, by N. Gregory MankiwMacroeconomics ECO62ECO62 Udayan RoyUdayan."— Presentation transcript:

1 Aggregate Demand II: Applying the IS-LM Model Chapter 12 of Macroeconomics, 8 th edition, by N. Gregory MankiwMacroeconomics ECO62ECO62 Udayan RoyUdayan Roy

2 Applying the IS-LM Model Section 12-1 shows how the IS-LM model that we studied in Chapter 11 can be applied to understand how an economy copes with disturbances (or, shocks) in the short run Section 12-3 extends section 12-1 by looking closely at – The Great Depression of the 1930s, and – The Great recession of Warning: I will skip section 12-2! Very sorry!

3 The IS-LM Model: Ch. 11 Assumptions Y = C + I + G – C = C o + C y ✕ (Y – T) – I = I o − I r r – G and T are exogenous M = M d = L(i) ✕ P ✕ Y L(i) = L o – L i ✕ i – i = r + Eπ – M, P and Eπ are exogenous

4 The IS-LM Model: Ch. 11 Summary Y = C + I + G – C = C o + C y ✕ (Y – T) – I = I o − I r r – G and T are exogenous M = M d = L(i) ✕ P ✕ Y L(i) = L o – L i ✕ i – i = r + Eπ – M, P and Eπ are exogenous

5 The IS-LM Model: Ch. 11 Summary Short-run equilibrium in the goods market is represented by a downward-sloping IS curve linking Y and r. Short-run equilibrium in the money market is represented by an upward-sloping LM curve linking Y and r. The intersection of the IS and LM curves determine the short-run equilibrium values of Y and r. The IS curve shifts right if there is: – an increase in C o + I o + G, or – a decrease in T. The LM curve shifts right if: – M/P or Eπ increases, or – L o decreases Y r IS LM

6 The LM curve represents money market equilibrium. Equilibrium in the IS -LM model The IS curve represents equilibrium in the goods market. IS Y r LM r1r1 Y1Y1

7 Shifts of the IS curve Recall from Chapter 11 that – the consumption function is C(Y – T) = C o + C y ✕ (Y – T), and – The investment function is I(r) = I o – I r ✕ r Recall also that the IS curve shifts right if there is: – an increase in C o + I o + G, or – a decrease in T. As a result, both Y and r increase IS Y r LM r1r1 Y1Y1

8 Shifts of the IS curve Similarly, the IS curve shifts left if there is: – a decrease in C o + I o + G, or – an increase in T. As a result, both Y and r decrease IS Y r LM r1r1 Y1Y1

9 Shifts of the IS curve In other words, we can make the following predictions: IS Y r LM r1r1 Y1Y1 IS-LM Predictions Yr C o + I o + G++ T−−

10 Ch. 11: Comparing fiscal policy in the Keynesian Cross and in the IS Curve Keynesian Cross IS Curve In the Keynesian Cross model, expansionary fiscal policy boosts GDP by an amount dictated by the multipliers. In the IS-LM model, expansionary fiscal policy also raises the real interest rate, thereby weakening the effect of fiscal policy on GDP. (Crowding-out effect) K.C. Spending Multiplier K.C. Tax-Cut Multiplier

11 Fiscal Policy is Weakened by the Crowding-Out Effect We have just seen that, in the IS-LM model, expansionary fiscal policy (G ↑ or T ↓ ) – leads to higher interest rates, which – exerts downward pressure on investment spending, which – exerts downward pressure on GDP and jobs. This negative aspect of expansionary fiscal policy is called the crowding-out effect This effect was absent in the Keynesian Cross model Thus, fiscal policy is less effective in the IS-LM model than in the Keynesian Cross model

12 causing GDP to rise. IS 1 An increase in government purchases: graph 1. IS curve shifts right Y r LM r1r1 Y1Y1 IS 2 Y2Y2 r2r This raises money demand, causing the interest rate to rise… …which reduces investment, so the final increase in Y 3.

13 IS 1 1. A tax cut Y r LM r1r1 Y1Y1 IS 2 Y2Y2 r2r2 Consumers save (1  MPC) of the tax cut, so the initial boost in spending is smaller for  T than for an equal  G… and the IS curve shifts by …so the effects on r and Y are smaller for  T than for an equal  G. 2.

14 Shifts of the LM curve IS Y r LM r1r1 Y1Y1

15 Shifts of the LM curve Similarly, the LM curve shifts left if there is: – a decrease in M/P or Eπ, or – an increase in L o. As a result, Y decreases and r increases IS Y r LM r1r1 Y1Y1

16 Shifts of the LM curve

17 Shifts of the LM curve Recall from Ch. 11 that, if expected inflation (Eπ) increases (decreases), the LM curve shifts down (up) by the exact same amount! Therefore, if Eπ decreases, r will increase, but by a smaller amount. Therefore, i = r + Eπ will decrease. IS Y r LM r1r1 Y1Y1

18 IS-LM Predictions IS CurveLM CurveYri C o + I o + G→+++ T←−−− M/PM/P→+−− EπEπ→+−+ LoLo ←−++ At this point, you should be able to do problems 1, 2, 3 (a) – (f), 4, and 5 on pages 352 – 353 of the textbook. Please try them.

19 Monetary Policy The practice of changing the quantity of money (M) in order to affect the macroeconomic outcome is called monetary policy – an increase in the quantity of money (M ↑ ) is called expansionary monetary policy, and – A decrease in the quantity of money (M ↓ ) is called contractionary monetary policy

20 Shifts of the LM curve When the central bank of a country makes changes to the quantity of money (M), – only the LM curve changes, and – the real interest rate (r) changes in the opposite direction – As expected inflation (Eπ) is assumed exogenous in the IS-LM model, when the real interest rate (r) changes, the nominal interest rate (i = r + Eπ) changes in the same direction. IS Y r LM r1r1 Y1Y1

21 Shifts of the LM curve One can think of the central bank as – targeting M and affecting r and i in the process, or as – targeting r and/or i and adjusting M to achieve the target IS Y r LM r1r1 Y1Y1

22 Monetary Policy Re-defined Therefore, one can re-define expansionary and contractionary monetary policy as follows: – Monetary policy is expansionary when the central bank attempts to reduce interest rates (real and nominal), and – Monetary policy is contractionary when the central bank attempts to increase the interest rates (real and nominal)

23 The Federal Funds Rate In the United States, the central bank (the Federal Reserve) formally describes its monetary policy by periodically announcing its desired or target level for a nominal interest rate called the Federal Funds Rate Having announced its target level for the FFR, the Fed then adjusts the money supply to steer the actual FFR as close to its target level as it can

24 The Federal Funds Rate The Federal Funds Rate is the interest rate that banks charge each other for overnight loans If the Fed wishes the FFR to be 1.8%, all it has to do is to announce that – it will lend money to any bank at 1.8% interest and – will pay 1.8% interest on deposits received from any bank

25 The Federal Funds Rate Given that the Fed expresses its monetary policy in terms of the target value of the Federal Funds Rate, we can re-define monetary policy as follows: – Monetary policy is expansionary when the Fed seeks to reduce the federal funds rate, and – Monetary policy is contractionary when the Fed seeks to increase the federal funds rate Keep in mind that, when expected inflation (Eπ) is exogenous, changes in nominal interest rates (such as the FFR) lead to equal changes in real interest rates

26 The Zero Lower Bound on Nominal Interest Rates We have seen that, when faced with a recession, the central bank can – Increase the money supply (M ↑ ) – Thereby shifting the LM curve right – Thereby reducing the real interest rate (r = i − Eπ ↓ ) and the nominal interest rate (i = r + Eπ ↓ ) and increasing GDP (Y ↑ ) to drag the economy out of the recession IS Y r LM r1r1 Y1Y1

27 The Zero Lower Bound on Nominal Interest Rates The problem is that there is a limit to how low the nominal interest rate can be Nominal interest rates (such as the federal funds rate) cannot be negative To deal with the 2008 economic crisis, the Fed reduced the FFR to zero But the recession persisted Unfortunately, the Fed could not reduce interest rates below zero: monetary policy had reached its limit IS Y r LM r1r1 Y1Y1

28 The Zero Lower Bound on Nominal Interest Rates: Crisis

29 The Zero Lower Bound on Nominal Interest Rates r = i − Eπ i minimum = 0 Therefore, r minimum = i minimum − Eπ = 0 − Eπ Therefore, r minimum = − Eπ For example, if Eπ = −3%, then r minimum = − Eπ = 3% IS Y r LM r1r1 Y1Y1 2.1%

30 The Zero Lower Bound on Nominal Interest Rates For example, in the diagram, the central bank will have to reduce the real interest rate to r = 2.1% in order to end the recession But suppose expected inflation is Eπ = − 3% Then, the nominal interest rate would have to be brought down to i = r + Eπ = 2.1 – 3.0 = – 0.9% Which, alas, is impossible IS Y r LM r1r1 Y1Y1 2.1% This example also shows how dangerous it can be if we have deflation and people begin to expect the deflation to continue

31 The Zero Lower Bound on Nominal Interest Rates If the nominal interest rate has been reduced all the way down to zero, and the economy is still stuck in a recession, the economy is said to be – at the zero lower bound, or – in a liquidity trap See page 350 of the textbook

32 The Zero Lower Bound on Nominal Interest Rates: Solutions When an economy is in a liquidity trap, monetary policy cannot be used to reduce interest rates any further But is there nothing else that can be done to bring the economy back to life? Yes, there is! Expansionary fiscal policy can be used And there’s something else that the monetary authorities (the central bank) can do: make a credible promise to be irresponsible!

33 The Zero Lower Bound on Nominal Interest Rates: Solutions In my example, – the central bank needs to reduce the real interest rate to r = 2.1% to end the recession – But expected inflation is Eπ = − 3% – So, the nominal interest rate would have to be brought down to i = – 0.9%, which, alas, is impossible Recall that the LM curve shifts right if either M or Eπ increases If the central bank promises to be irresponsible and to create rapid inflation in the future, and if people believe its promise, then Eπ will increase, say from − 3% to +1% Then the nominal interest rate required for full-employment will be i = r + Eπ = = 3.1%, which is definitely attainable IS Y r LM r1r1 Y1Y1 2.1% The zero-lower-bound problem can be solved if the central bank can credibly promise to be irresponsible!

34 The Zero Lower Bound on Nominal Interest Rates: Solutions Although this chapter assumes a closed economy, in reality foreign trade does matter. So, the central bank can – print domestic currency, and – use it to buy foreign currency, – thereby making the domestic currency cheaper relative to the foreign currency, – thereby stimulating exports, – thereby ending the recession!

35 The Zero Lower Bound on Nominal Interest Rates: Solutions Even when short-term interest rates such as the federal funds rate are at zero percent, the central bank can print money and make long-term loans to the government, to businesses, to home- buyers who need mortgages, etc. This would reduce long-term interest rates directly, thereby stimulating spending by the borrowers This strategy—called quantitative easing—may also end a recession

36 Interaction between monetary and fiscal policy IS-LM Model: Monetary and fiscal policy variables (M, G, and T ) are exogenous. Real world: Monetary policymakers may adjust M in response to changes in fiscal policy, or vice versa. Such responses by the central bank may affect the effectiveness of fiscal policy

37 The Fed’s response to  G > 0 Suppose the government increases G. Possible Fed responses: 1. hold M constant 2. hold r constant 3. hold Y constant In each case, the effects of  G on  Y are different…

38 When G increases, the IS curve shifts right. IS 1 Response 1: Hold M constant Y r LM r1r1 Y1Y1 IS 2 Y2Y2 r2r2 If Fed holds M constant, then LM curve does not shift. As a result, interest rates rise. This has a crowding- out effect. Consequently, GDP increases, but not a lot.

39 If Congress raises G, the IS curve shifts right. IS 1 Response 2: Hold r constant Y r LM 1 r1r1 Y1Y1 IS 2 Y2Y2 r2r2 To keep r constant, Fed increases M to shift LM curve right. LM 2 Y3Y3 Results:

40 IS 1 Response 3: Hold Y constant Y r LM 1 r1r1 IS 2 Y2Y2 r2r2 To keep Y constant, Fed reduces M to shift LM curve left. LM 2 Results: Y1Y1 r3r3 If Congress raises G, the IS curve shifts right. At this point, you should be able to do problem 7 on page 353 of the textbook. Please try it.

41 Estimates of fiscal policy multipliers from the DRI macroeconometric model Assumption about monetary policy Estimated value of  Y /  G Fed holds nominal interest rate constant Fed holds money supply constant Estimated value of  Y /  T  1.19  0.26 A macroeconometric model is a more elaborate version of our IS-LM model, with the parameters given the numerical values that they are estimated to have, based on historical data.

42 Shocks in the IS -LM model IS shocks: exogenous changes in the demand for goods & services. Examples: – stock market boom or crash  change in households’ wealth   C – change in business or consumer confidence or expectations   I and/or  C

43 Shocks in the IS -LM model LM shocks: exogenous changes in the demand for money. Examples: – a wave of credit card fraud increases demand for money. – more ATMs or the Internet reduce money demand.

44 NOW YOU TRY: Analyze shocks with the IS-LM Model Use the IS-LM model to analyze the effects of 1.a boom in the stock market that makes consumers wealthier. 2.after a wave of credit card fraud, consumers using cash more frequently in transactions. For each shock, a.use the IS-LM diagram to show the effects of the shock on Y and r. b.determine what happens to C, I, and the unemployment rate.

45 CASE STUDY: THE U.S. RECESSION OF 2001

46 The U.S. Recession of % on 9/00 4.9% on 8/01 6.3% on 6/03 5.0% on 7/05

47 The U.S. Recession of 2001 Growth of GDP was negative in the 1 st and 3 rd quarters of 2001 That’s essentially before 9/11

48 Recall: IS-LM Predictions IS-LM Predictions IS CurveLM CurveYri C o + I o + G→+++ T←−−− M/PM/P→+−− EπEπ→+−+ LoLo ←−++

49 The U.S. Recession of 2001 Why? Demand shocks moved the IS curve left – The “tech bubble” ended and stocks fell 25% between 8/00 and 8/01 – 9/11 attacks led to a 12% fall in stock prices in one week and a huge rise in uncertainty – Scandals at Enron, WorldCom and other corporations led to stock price declines and a decline in trust and a rise in uncertainty – Lower household wealth reduced C o and higher uncertainty reduced I o IS Y r LM r1r1 Y1Y1

50 CASE STUDY: The U.S. recession of 2001 Causes: 1) Stock market decline   C Index (1942 = 100) Standard & Poor’s 500

51 The U.S. Recession of 2001 Fiscal stimulus moved IS curve right – Major tax cuts were enacted in 2001 and 2003 – Government spending was boosted to rebuild NYC, and to bail out the airline industry Fed printed money and moved LM curve right – Interest rate on 3-month Treasury bills fell 6.4% in 11/00 3.3% in 8/01 0.9% in 7/03 IS 1 Y r LM 1 r1r1 Y1Y1 IS 2 LM 2 Y3Y3 All three tools—G, T and M—were used

52 CASE STUDY: The U.S. recession of 2001 Monetary policy response: shifted LM curve right Three-month T-Bill Rate /01/200004/02/ /03/200010/03/ /03/200104/05/200107/06/200110/06/200101/06/200204/08/200207/09/ /09/ /09/200304/11/2003

53 What is the Fed’s policy instrument? The news media commonly report the Fed’s policy changes as interest rate changes, as if the Fed has direct control over market interest rates. In fact, the Fed targets the federal funds rate – the interest rate banks charge one another on overnight loans. The Fed changes the money supply and shifts the LM curve to achieve its target. Other short-term rates typically move with the federal funds rate.

54 What is the Fed’s policy instrument? Why does the Fed target interest rates instead of the money supply? 1)They are easier to measure than the money supply. 2)The Fed might believe that LM shocks are more prevalent than IS shocks. If so, then targeting the interest rate stabilizes income better than targeting the money supply. (See end-of-chapter Problem 7 on p.353.)

55 Skip! I am skipping section 11-2

56 THE GREAT DEPRESSION

57 The Great Depression Unemployment (right scale) Real GNP (left scale) billions of 1958 dollars percent of labor force

58 THE SPENDING HYPOTHESIS: Shocks to the IS curve asserts that the Depression was largely due to an exogenous fall in the demand for goods and services – a leftward shift of the IS curve. evidence: output and interest rates both fell in early 1930s, which is what a leftward IS shift would cause. IS Y r LM r1r1 Y1Y1

59 THE SPENDING HYPOTHESIS: Reasons for the IS shift Stock market crash  exogenous  C – Oct-Dec 1929: S&P 500 fell 17% – Oct 1929-Dec 1933: S&P 500 fell 71% Drop in investment – “correction” after overbuilding in the 1920s – widespread bank failures in early 1930s made it harder to obtain financing for investment Contractionary fiscal policy – Politicians raised tax rates in 1932 and cut spending to combat increasing deficits.

60 THE MONEY HYPOTHESIS: A shock to the LM curve asserts that the Depression was largely due to huge fall in the money supply. evidence: M1 fell 25% during But, two problems with this hypothesis: – P fell even more, so M/P actually rose slightly during – nominal interest rates fell, which is the opposite of what a leftward LM shift would cause.

61 THE MONEY HYPOTHESIS AGAIN: The effects of falling prices asserts that the severity of the Depression was due to a huge deflation: – P fell 25% during This deflation was probably caused by the fall in M, so perhaps money played an important role after all. In what ways does a deflation affect the economy?

62 THE MONEY HYPOTHESIS AGAIN: The effects of falling prices The stabilizing effects of deflation:  P   (M/P )  LM shifts right   Y Pigou effect:  P   (M/P )  consumers’ wealth    C  IS shifts right   Y

63 IS-LM Predictions IS CurveLM CurveYri C o + I o + G→+++ T←−−− M/PM/P→+−− EπEπ→+−+ LoLo ←−++

64 THE MONEY HYPOTHESIS AGAIN: The effects of falling prices The destabilizing effects of expected deflation:  E  LM curve shifts left  r  and I (r )   planned expenditure   income and output  Also, the nominal interest rate decreases (i↓): – see IS-LM predictions grid IS Y r LM r1r1 Y1Y1

65 THE MONEY HYPOTHESIS AGAIN: The effects of falling prices The destabilizing effects of unexpected deflation: debt-deflation theory  P (if unexpected)  transfers purchasing power from borrowers to lenders  borrowers spend less, lenders spend more  if borrowers’ propensity to spend is larger than lenders’, then aggregate spending falls, the IS curve shifts left, and Y falls

66 The evidence on output and nominal interest rates Note that, other than the money hypothesis, all the other hypotheses—the spending hypothesis, the debt- deflation hypothesis, and the deflationary expectations hypothesis—predict falling real GDP and falling nominal interest rates This is exactly what happened in the early stages of the Great Depression The spending hypothesis and the debt-deflation hypothesis both predict falling real interest rates, whereas the deflationary expectations hypothesis predicts rising real interest rates Therefore, evidence on real interest rates is crucial in identifying suitable explanations for the Great Depression

67 Why another Depression is unlikely Policymakers (or their advisors) now know much more about macroeconomics: – The Fed knows better than to let M fall so much, especially during a contraction. – Fiscal policymakers know better than to raise taxes or cut spending during a contraction. Federal deposit insurance makes widespread bank failures very unlikely. Automatic stabilizers make fiscal policy expansionary during an economic downturn.

68 THE FINANCIAL CRISIS AND ECONOMIC DOWNTURN OF 2008 AND 2009

69 CASE STUDY The Financial Crisis & Recession 2009: Real GDP fell, unemployment rate approached 10% Important factors in the crisis: – early 2000s Federal Reserve interest rate policy – sub-prime mortgage crisis – bursting of house price bubble, rising foreclosure rates – falling stock prices – failing financial institutions – declining consumer confidence, drop in spending on consumer durables and investment goods

70 A Too-Brief and Too-Simple Explanation The price of housing had risen to unsustainable levels. When home prices inevitably crashed, people suddenly felt poor and cut back their spending plans. This fall in planned expenditure brought about the Great Recession of

71 The Housing Bubble Inflates, then Deflates The S&P Case-Shiller 20-City Home Price Index went from – 100 in Jan 2000, to – in April 2006, to – in May 2009, to – in Dec 2010 Why did the housing bubble inflate?

72 The Housing Bubble: Reasons The Fed kept the interest rates too low for too long Securitization technology got a lot fancier in the mortgage bond market The government regulators were sleeping Pretty much everybody believed that home prices could never fall

73 The Housing Bubble: Low FFR The Fed had reduced the Federal Funds Rate to fight the Recession of After that recession ended, the Fed continued to keep interest rates low until 2004 – The Fed was watching inflation, which remained tame. Consequently, the Fed saw little reason to raise interest rates. – The Fed did not believe that housing prices had formed a bubble … until it was blindingly obvious

74 The Housing Bubble: Securitization In the past, people with money did not like to lend money to home buyers because such loans were risky and had unreliable returns But the advent of new financial technologies called securitization and tranching made people with money suddenly eager to lend to home buyers

75 The Housing Bubble: Weak Regulators The financial sector was regulated by people who were ideologically opposed to regulation They turned a blind eye to even the worst lending practices

76 The Housing Bubble Inflates The Fed’s low-interest policy and financial innovation made it easy for home buyers to borrow money Lax regulation allowed subprime lending – That is, lending to people who had few assets and/or prospects that would make repayment likely The belief that home prices would keep rising made it unnecessary to worry about the credit worthiness of borrowers

77 The Housing Bubble Deflates After mid-2006, home prices started to fall – Home owners began to default on their loans – Foreclosures increased – This flooded the market with more homes for sale – Which led to further declines in home prices – These cascading and self-reinforcing home price declines made people feel poor – Consumption spending fell

78 The Housing Bubble Deflates After mid-2006, home prices started to fall – The financial institutions that had made mortgage loans faced huge losses when borrowers began to default – These institutions began to second guess their ability to spot good borrowers. So, they reduced lending – Even financial institutions that had not made bad loans were scared to lend because they feared that the borrower may have made bad investments and would soon go bankrupt – Business investment spending collapsed

79 The Housing Bubble Deflates After mid-2006, home prices started to fall – Financial institutions were revealed to have suffered huge losses – Non-financial businesses were not getting loans and were shutting down – But a lack of transparency meant that it was not possible to figure out which companies would collapse next – This caused great uncertainty – People with money sold off their stocks and bonds – The decline in stock prices made people feel poor – Consumption spending fell

80 The Housing Bubble Deflates The collapse of the housing bubble led, through a complex chain of causation, to major declines in consumption and investment spending One can think of all this as a shift of the IS curve to the left This brings about a recession, with falling output and rising unemployment

81 The Fed’s Response The Federal Reserve reduced the Federal Funds Rate – from 5.25% in Sept 2007 – to essentially zero in Dec 2008 The Fed had reached the zero lower bound and could not go any further The Fed is now trying less orthodox measures, called quantitative easing, to reduce long- term interest rates

82 The Federal Government’s Response In October 2008, the outgoing Bush administration enacted the Troubled Assets Recovery Program (TARP) that spent $700 billion to revive Wall Street In January 2009, the incoming Obama administration enacted the American Recovery and Reinvestment Act (ARRA), which consisted of $800 billion in tax cuts and spending initiatives to spread over two years

83 Slow Recovery The Great Recession officially ended in June 2009 But the recovery has been very slow Real GDP grew at 3.1% in the fourth quarter of 2010 The unemployment rate was at 8.9% in February 2011

84 THE GREAT RECESSION CHARTBOOK

85 Interest rates and house prices

86 Change in U.S. house price index and rate of new foreclosures,

87 House price change and new foreclosures, 2006:Q3 – 2009Q1 New foreclosures, % of all mortgages Cumulative change in house price index Nevada Georgia Colorado Texas Alaska Wyoming Arizona California Florida S. Dakota Illinois Michigan Rhode Island N. Dakota Oregon Ohio New Jersey Hawaii

88 U.S. bank failures by year, * as of July 24, *

89 Major U.S. stock indexes (% change from 52 weeks earlier)

90 Consumer sentiment and growth in consumer durables and investment spending

91 Real GDP growth and Unemployment

92 The Fed Tried: M/P Kept Rising

93 But the Fed hit the zero lower bound

94 Falling mortgage rates helped Note that there is a link between the two rates, though weak Mortgage rates were very low between ‘04 and ‘06. They may have contributed to the housing bubble In hindsight, the FFR should have been higher in But inflation was low.

95 Record low mortgage rates The unusually low mortgage rates may have helped to inflate the housing bubble. Mortgage rates are even lower now. But credit standards have been tightened. In any case, the economy is still weak. So, don’t expect another housing bubble.

96 The Housing Bubble Inflates, and then Deflates

97 The Stock Market Tanks In 2007, it becomes clear that banks would get hit by the collapse of the housing bubble

98 The “Fear Index” Spikes

99

100 Consumption Spending Falls In 2007, the growth rate of consumption slowed faster than GDP did. This was unusual.

101 Business Investment Tanks From 2007, investment, which includes new housing, absolutely crashed.

102 Unemployment Shot Up Remember Okun’s Law?

103 Unemployment Shot Up Remember Okun’s Law? Because GDP growth has remained below 3%, unemployment has remained stubbornly high.

104 Inflation Fell Sharply The Fed pays more attention to the “core inflation rate,” which ignores food and energy. Now you see why. The downward trend in core inflation is a worry: we don’t need deflation.

105 A Yawning Budget Deficit! Has government spending risen at an unusually rapid rate? Not really. The main budgetary problem has been caused by the crashing tax revenues.

106 A Yawning Budget Deficit! Has government spending risen at an unusually rapid rate? Not really. The main budgetary problem has been caused by the crashing tax revenues.

107 A Yawning Budget Deficit! Has government spending risen at an unusually rapid rate? Not really. The main budgetary problem has been caused by the crashing tax revenues.

108 This recession was special: job losses Horizontal axis shows months. Vertical axis shows the ratio of that month’s nonfarm payrolls to the nonfarm payrolls at the start of recession. And this doesn’t even account for the fact that the working- age population has continued to grow, meaning that if the economy were healthy we should have more jobs today than we had before the recession.


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