Robert Hall: The Long Slump Villain Zero Lower Bound The Great Recession: Decline in Aggregate Demand Excess stock of housing High consumer indebtedness Think deleveraging shock (Eggertsson and Krugman) Increased financial frictions  Credit Crunch Self-correcting adjustment When some sectors decline, need lower real interest rate for other sectors to compensate Hall’s World Liquidity Constrained Unconstrained Consumers Consumers C down  i down  C up ZLB obstructs self-correction

ZLB  A Long Slump Real interest rate = Nominal Rate – Expected Inflation Wither Inflation? – NAIRU is failure … forget about a “natural rate” of unemployment – Inflation responds to u – u lowest in 11 mos – The good news: after 11 months of slump, no pressure for a drop in inflation rate…we’re not headed for deflation – The bad news: with unemployment where it is, can’t expect inflation to increase » Inflation won’t produce a low enough real rate

Hall’s DSGE Model Cobb-Douglas production function Cobb-Douglas utility functions: – Liquidity Constrained Consumers – Unconstrained Consumers Search and match job market (DMP) – Worker “pays” for her job – If PV(job) falls, unemployment increases Financial sector with zero lower bound – Cost of capital and financial frictions Spread that intermediaries earn keeps them from absconding When intermediary net worth down, it takes a bigger spread  friction Bigger spread  heightened threat of borrower default  increased cost of intermediation  increased credit rationing  CREDIT CRUNCH Results In absence of ZLB, economy operates at full employment BUT, ZLB and low inflation  “Pinned” real rate  Sustained Slump

Lessons from Our Lessons Romer on Great Depression: Descent and Recovery (cited by Hall) – Gold standard mindset  cruelly high real interest rate – Gold constraint  reflation and recovery Reflation driven by gold inflows, not policy (per Romer) The German Inflation – Fixed discount rate (5%) and high inflation  Negative real interest rate  High employment

Hall on Policy Fiscal Stimulus? It is not that government purchases are ineffective but that government is incapable of executing a rapid and large increase in purchases Price level targeting If inflation lags target, public would expect high inflation as Central Bank tries to catch up to price target: π e up  i real down Phased in Value Added Tax (VAT)  buy now! Currency depreciation  buy now! Subsidize consumption until slump ends…then tax Summers (in context of DMP labor market): Payroll tax cut  small reduction in wage cost  big increase in profit margin  HIRING