1. Wayne Carroll Department of Economics University of Wisconsin-Eau Claire carrolwd@uwec.edu We Survived the Great Recession of 2008-09 – WHAT NOW?

2. The Great Recession Started in December 2007 and probably ended around July 2009. Aug 1929 - March 193343 months Dec 2007 – July 200920 months Nov 1973 - March 197516 months July 1981 - Nov 198216 months July 1990 - March 19918 months March 2001 - Nov 20018 months Source: http://wwwdev.nber.org/cycles/cyclesmain.html

3. Why was this recession special? The deepest since the Great Depression. The government response to this recession was extraordinary and will have a lasting, historic impact. The economy has been behaving differently from before, so we’re in uncharted territory.

4. How do we measure recessions? Real GDP Total employment Unemployment rate Bank credit Industrial production Home sales and prices Stock market prices and other asset prices Others The “official” word on recessions comes from the National Bureau of Economic Research (NBER).NBER

5. History’s lessons The Great Depression U.S. recessions: 2001: following the bursting of the dot.com bubble 1990-91: perhaps a consequence of the S & L crisis of the late 1980s 1981-82: caused by the Fed’s anti-inflation policies 1974-75: following a sharp spike in OPEC oil prices

9. What about Wisconsin? Wisconsin tends to follow national economic trends (more or less) Wisconsin was hit by the recession about as hard as the rest of the nation, and it will probably recover (or not) with the rest of the nation

13. How did we get here? Broad expansion in mortgage lending and increases in home prices starting in the 1990s. The housing bubble burst in 2006-7. Many home owners “underwater” Increase in mortgage default rates Financial problems for holders of mortgage-backed securities (http://faculty.chicagobooth.edu/raghuram.rajan/research/TheCreditCrisisDougDiamondRaghuRajanAEADec2008.pdf)

14. How did we get here? Risks were spread in new ways (or at an unprecedented scale) in the housing bubble, so the downturn was much broader and deeper than anyone thought was possible. (http://www.hbs.edu/research/pdf/09-060.pdf)http://www.hbs.edu/research/pdf/09-060.pdf Crisis of confidence  recession accompanied by financial crisis Consumers are reluctant to spend or borrow Banks are reluctant to lend Businesses are reluctant to invest in capital projects

15. Crisis of Confidence

17. How did we get here? History offers lessons for policy makers: Recessions can be long-lasting. The Fed did not act decisively in the Great Depression – it “had to keep its powder dry for a real emergency.” Japan suffered a deep recession and deflation starting in 1989, and the Japanese government did not respond quickly.

18. How did we get here?

19. Learning from history : The Federal Reserve System has taken extraordinary steps to rescue the financial system.  The Fed increased the nation’s money supply at an annual rate of over 45% in the fourth quarter of 2008.  The Fed has dropped its target interest rate to essentially zero.  The Fed has injected hundreds of billions of dollars into banks, AIG, and other financial institutions. (http://www.federalreserve.gov/monetarypolicy/bst.htm)

20. http://www.frbatlanta.org/documents/research/highlights/finhighlights/FH_090810.pdf

21. How did we get here? Learning from history : Congress and the president(s) enacted fiscal stimulus programs on an unprecedented (peacetime) scale The stimulus packages have boosted the economy – how much?? – and raised the federal budget deficit.

22. How did we get here? Emergency Economic Stabilization Act of 2008:  Troubled Asset Relief Program (TARP) – Treasury could spend $700 billion to recapitalize banks The American Recovery and Reinvestment Act of 2009:  $787 billion injection of funds into the U.S. economy, including $212 billion in tax cuts, in the next ten years (http://cboblog.cbo.gov/?p=208)http://cboblog.cbo.gov/?p=208 President Obama’s latest proposals. (http://www.nytimes.com/aponline/2010/09/10/us/politics/AP-US- Obama.html?scp=2&sq=infrastructure&st=nyt)http://www.nytimes.com/aponline/2010/09/10/us/politics/AP-US- Obama.html?scp=2&sq=infrastructure&st=nyt The federal budget deficit for fiscal year 2010 was $1.3 trillion dollars, or about 9% of GDP. (http://www.cbo.gov/doc.cfm?index=11705)http://www.cbo.gov/doc.cfm?index=11705

24. Projected debt in 2011 from http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=economic_indicators&docid=f:32au10.txt.pdfhttp://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=economic_indicators&docid=f:32au10.txt.pdf

25. How did we get here? Consequence: a deep financial crisis Lots of uncertainty, so banks and others couldn’t determine the value of many assets ==> toxic assets. Drops in the values of assets eroded bank capital, which serves as a buffer against losses. Many banks have failed, and failure has become more likely for many others. Banks and other financial institutions became reluctant to lend or to enter into other transactions, because they could not judge the soundness of potential borrowers and other counterparties. Facing deep uncertainty, it makes sense for banks to cut their lending and build their capital back up to comfortable levels.

26. Possible Future Scenarios A double-dip recession. Many years of deflation and stagnation – like in Japan in the last twenty years. Fiscal crisis and high inflation as a result of our high national debt Rapid recovery – like in the early 1980s. Most likely: a long, slow recovery.

27. Double-dip Recession? The economy has slowed in recent months (although it’s still growing). State and local government spending continues to fall. Federal stimulus spending is declining. But the economy will probably continue to grow.

28. Deflation and Stagnation? The scary monster hiding under the bed: Japan in the last twenty years. The 1990s were “the lost decade.” Housing bubble in late 1980s  bank crisis in 1990s Slow growth in real GDP, deflation, and high unemployment throughout the last twenty years (http://research.stlouisfed.org/publications/review/10/09/Bullard.pdf)http://research.stlouisfed.org/publications/review/10/09/Bullard.pdf

29. Deflation and Stagnation? http://www.economist.com/finance/displaystory.cfm?story_id=13415153 Japan in the last twenty years: what we want to avoid!

30. Deflation and Stagnation?

31. The Federal Reserve System is trying to ensure that we’ll have some inflation over the next few years to avoid Japan’s fate: (http://www.federalreserve.gov/newsevents/press/monetary/20100810a.htm)http://www.federalreserve.gov/newsevents/press/monetary/20100810a.htm The Fed probably can keep us out of a deflationary trap.

32. Fiscal Crisis and High Inflation? In theory (or maybe in our worst nightmares), a huge national debt could result in: Bankruptcy: the U.S. government might have to default on its debt, causing interest rates to skyrocket (the fate that threatened Greece last spring). High inflation: the government and the Fed might pay off the debt by “printing money,” which would cause inflation.

33. Fiscal Crisis and High Inflation? Bankruptcy? Not likely. The U.S. economy “grew out of” deficits in the 1990s and could do it again in the long run. U.S. Treasury bonds remain an attractive investment around the world. High inflation? Also not likely. There’s not much evidence of inflation on the horizon. The Fed is on the watch for inflation. Reducing the deficit (by reducing government spending) would tend to slow the economy further in the short run – not a good move now.

34. Rapid Recovery or Slow Growth? Reasons for optimism: There is a lot of excess capacity in the U.S. economy: Millions of workers looking for work Banks holding more capital and extraordinary levels of reserves that could be lent out Consumers reducing their debts and their spending If confidence is restored, the economy could take off quickly – like it did after the 1981-82 recession.

35. Rapid Recovery or Slow Growth?

37. Reasons for pessimism: Many households are still deeply in debt, and it will take longer for them to dig out. There’s a lot of excess capacity in the housing market, so housing starts are not likely to pick up soon. Many workers have been unemployed (or out of the labor force) for a long time, and their skills are getting rusty. Productivity might fall as they return to work.

38. My Predictions 2011 will be a good year. 2012 will be an even better year. …unless Congress chooses to cut government spending in the short run, which will slow the recovery.