Economic Indicators - Intermediate Macroeconomics

Embed Size (px)

Citation preview

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    1/25

    Economic Indicators:

    Group 6ECO 314A

    Ashlyn -

    Anthony -

    Brian -

    Jake -

    Margaret Pesikov

    10/12/2011

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    2/25

    Table of Contents

    Part I:...Page 2

    Leading and Lagging Indicators

    Part II: .Page 5

    Using the Stock Market as Economic Indicators

    Part III: .Page 10

    The Financial Market and Sub-Prime Crisis

    Part IV: .Page 14

    TARP and the Financial Recovery Plan

    Part V: ..Page 19

    Commercial Paper Funding Facility (CPFF), Term Securities Lending Facility (TSLF),

    and AMLF

    Works Cited..Page 22

    2

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    3/25

    Part I: Leading and Lagging Indicators

    The economic indexes contain the key elements of an economy. They are designed to

    signal peaks and troughs in the business cycle. The leading and lagging economic indexes are

    essentially averages of several leading, or lagging indicators. They are constructed to summarize

    and reveal common turning point patterns in economic data. The index is presented in a clearer

    and more convincing manner than any individual component because it smooths out some of the

    volatility of individual components.

    Leading indicators are indicators that usually change before the economy as a whole

    changes. They are therefore useful as short-term predictors of the economy. Stock market returns

    are a leading indicator. The stock market usually begins to decline before the economy as a

    whole declines and usually begins to improve before the general economy begins to recover from

    a slump.

    The Leading Economic Index (LEI) for the U.S. increased 0.3 percent in August to 116.2

    (2004 = 100), following a 0.6 percent increase in July and a 0.3 percent increase in June. The

    August increase in the U.S. LEI was driven by components measuring financial and monetary

    conditions. The leading indicators point to rising risks and volatility, and increasing concerns

    about the health of the expansion. There is growing risk that sustained weak confidence could

    put downward pressure on demand and business activity, causing the economy to potentially dip

    into recession.

    3

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    4/25

    Leading Economic Index Factor

    1 Average weekly hours, manufacturing 0.2725

    2 Average weekly initial claims for unemployment insurance 0.0322

    3 Manufacturers new orders, consumer goods and materials 0.0809

    4 Index of supplier deliveries vendor performance 0.0715

    5 Manufacturers new orders, nondefense capital goods 0.0192

    6 Building permits, new private housing units 0.0263

    7 Stock prices, 500 common stocks 0.0373

    8 Money supply, M2 0.3248

    9 Interest rate spread, 10-year Treasury bonds less federal funds 0.1058

    10 Index of consumer expectations 0.0295

    The Lagging Economic Index (LAG) increased 0.3 percent in August to 110.3 (2004 =

    100), following a 0.3 percent increase in July, and a 0.3 percent increase in June. Lagging

    indicators are indicators that usually change after the economy as a whole does. Typically the lag

    is a few quarters of a year. The unemployment rate is a lagging indicator. Employment tends to

    increase two or three quarters after an upturn in the general economy.

    Lagging Economic Index

    1 Average duration of unemployment 0.0356

    2 Inventories to sales ratio, manufacturing and trade 0.1192

    3 Labor cost per unit of output, manufacturing 0.0631

    4 Average prime rate 0.2731

    5 Commercial and industrial loans 0.1071

    4

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    5/25

    6 Consumer installment credit to personal income ratio 0.2117

    7 Consumer price index for services 0.1902

    Part II: Using the Stock Market as Economic Indicators

    5

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    6/25

    In order to predict the future economic status of the country, the stock market is

    commonly used as an indicator. Changes in the stock market often reflect changes in the

    economy. Although this is not always the case, whenever the stock market has declined

    substantially, a fear of a recession sets in. Based on the current status of the stock market, some

    economists fear the second part of a double-dip recession is in the future for the United States.

    Stocks are used as economic indicators for many reasons. One reason can be found in

    Tobins q theory which explains how the stock market can reflect the economy as a whole. The

    theory represents the ratio of the market value of installed capital to its replacement cost.

    Therefore, when there is a fall in a stocks price, there is a fall in Tobins q. According to

    Gregory Mankiws Macroeconomics, this means that investment is lower at any given interest

    rate and the result leads to lower output and employment because of the decreased demand

    for goods (Mankiw, 535). Another reason is that stock is part of household wealth. Therefore,

    when stock prices decrease, people become poorer, causing less consumption, a decrease in

    demand, and lower output. Dips in stock prices might also act as economic indicators because

    they may reflect lags in technology which would prevent economic growth. This would cause the

    supply and output to move more slowly than expected (Mankiw, 535).

    When analyzing the stock market as an indicator, one may look at the leading physical

    stock market, the New York Stock Exchange (NYSE). The exchanges that take place at the

    NYSE are auction exchanges, where the buyers bid on the sellers auctions. In order to trade

    here, one has to have a seat, which is usually reserved for a representative from leading

    companies. The index includes 1863 companies (1519 of them being domestic) and is made up

    6

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    7/25

    of common stocks, ADRs, ADSs, tracking stocks, and REITs are allowed to be included in the

    NYSE Composite index (nyse.com).

    Another stock market to analyze is the National Association of Securities Dealers

    Automatic Quotations (NASDAQ), which is the leading over-the-counter dealer market in the

    Unites States. It is an automatic information network, which allows dealers and buyers to

    negotiate prices for securities. Although the stocks listed on the NASDAQ must maintain a $1

    million stock price, NASDAQ is the largest market with about 3,700 listed companies

    (Derderian).

    The Standard & Poor 500 Stock Index (S&P 500) is also used as an economic indicator.

    It is made up of 500 different stocks for the purpose of being a representation of the overall

    market. The stocks traded in this market are from the leading companies in the leading

    industries, which represents a significant portion of the United States market (nyse.com).

    Based on evidence of all three exchanges historical prices, the stock markets act as

    economic indicators. When looking at the stock market from 2008 to 2009, the S&P 500, NYSE,

    and NASDAQ all show dips. At the same time, the economy was going through a recession,

    which shows that the stock market is a good indicator of the economic status of the country. The

    evidence is shown here:

    7

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    8/25

    Figure 1: S&P 500 from 2007 until 2011

    Figure 2: NYSE from 2008 until late 2009

    Figure 3: NASDAQ from 2008 until 2009

    8

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    9/25

    By analyzing the above figures, the dips take place in late 2008 and early 2009, which

    was when the recession took place. Since the stock prices go along with Tobins q Theory, it

    shows that a dip in stock prices is reflected in the economic status of the country.

    Currently, economic analysts are examining the stock market to predict the economic

    status of the country. According to a recent article published on marketwatch.com, the S&P 500

    price recently fell 32.19 points, which was its lowest close since September 2010. The article

    also states that some analysts are predicting the S&P 500 to continue decreasing into the 2010

    lows (Hong). Although the article mainly used the S&P 500 to predict the economic status, all

    three indexes are currently following the same pattern, which is shown in these figures:

    Figure 4: S&P 500 Past 6 Months

    Figure 5: NYSE Past 6 Months

    9

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    10/25

    Figure 6: NASDAQ Past 6 Months

    Based on the three figures, all three indexes have similar dips that not only reflect each

    other, but also reflect the economys status as analysts fear the past recession was part of a

    double-dip recession. Since the market is commonly used to predict what is in store for the

    United States, it is considered an economic indicator.

    10

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    11/25

    Part III: The Financial Market and Sub-Prime Crisis

    December 2007 marked the beginning of what most individuals now refer to as the Great

    Recession. As a result of the recession, economic activity declined causing an increase in

    unemployment, housing foreclosures and a steep downturn in various financial markets.

    Although many professionals disagree about various aspects of the recession, most assert that the

    primary cause of the recession was a crisis in the housing industry, mainly the bursting of the

    housing bubble. In addition, an increase in subprime mortgages in the marketplace also

    contributed to the housing markets downfall.

    One major effect that resulted from the recession was the impact on the financial market.

    The financial market provides a means for individuals to buy, sell and trade securities such as

    stocks, bonds and commodities among other financial instruments. Essentially, such markets

    bring together buyers and sellers in an effort to promote an efficient economy. During the Great

    Recession, measures of financial markets, for instance the stock market, sharply declined and

    remained volatile, as shown below. Overall, the stock market was just one of several markets,

    institutions and individuals that were negatively impacted by the recession

    11

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    12/25

    In addition, the housing crisis, which is detailed below, was negatively impacted by the

    subprime mortgages during the recession. Such mortgages impacted the financial markets and in

    turn resulted in a global recession. According to the PEW research poll just over half of all

    working Americans faced some form of work related hardship such as being laid off or taking

    a pay cut. Furthermore, according to the Bureau of Labor Statistics, unemployment rates

    increased from 5.8 in 2008 to 9.3 in 2009 and additionally increased .3 percent in 2010. As a

    result, consumer confidence remained at all-time lows further exacerbated the preexisting issues.

    Prior to the start of the recession housing prices steadily increased in the early to mid-

    2000s but subsequently declined in 2007. The graph below indicates the rise and decline in

    housing prices with respect to time.

    12

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    13/25

    Housing Prices from 1970-2010

    Prior to the decline in the housing market, homeowners, lenders and financial institutions

    all benefited from the continual increase in housing prices. Lenders repackaged mortgages to

    investments banks, both of whom made substantial profit. Due to the successful gains of such

    transactions institutions, lenders and banks all requested to purchase more mortgages or

    mortgage backed securities. The high demand of mortgages combined with the low supply of

    quality homeowners, resulted in lenders deriving subprime mortgages to sell to homeowners who

    did not have high enough credit to but prime loans. Such subprime loan required little

    documentation, proof of income, or down payment. In addition, the rates were higher in order to

    compensate for the increased risk. Due to the high payments and the homeowners inability to

    make their monthly mortgage payments, banks and other lenders began to own houses instead of

    receiving the anticipated monthly payments. As more and more homeowners faced foreclosure,

    the value houses began to decrease due to having an increased supply and less demand.

    13

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    14/25

    Currently, approximately 1.5 million homes are foreclosed and years after the beginning of the

    recession, the percentage of new foreclosures is still increasing. For example from July to August

    of 2011 the National Foreclosure Rate increased 7.21 percent.

    Homeowners with prime loans that are still able to pay their mortgages also suffer as they

    are still paying their loan equivalent to the original value of their home when they first purchase

    it. However, the value of their house has declined and the amount they are paying far exceeds

    that worth of the house.

    Many lending institutions and borrowers based mortgage assumptions on the continued

    increase in housing prices and as a result allocated what they believed as the appropriate risk and

    return to such loans. As a result of the sub-prime mortgages that many individuals held, the

    decline in housing prices resulted in homeowners being unable to pay their mortgage interest

    rates. As a result, no institutions or potential homeowners were purchasing loans or mortgages

    creating a credit freeze.

    14

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    15/25

    Part IV: TARP and the Financial Recovery Plan

    The Troubled Asset Relief Program (TARP) was suggested on September 19th of 2008 by

    the Secretary of the Treasury, Henry Paulson. This program was also referred to as the

    Emergency Stabilization Act of 2008. TARP was approved by the House of Representatives on

    October 3rd of the same year, under George Bushs presidency. TARP was created in an attempt

    to respond effectively to the subprime mortgage crisis.

    Subprime mortgages are loans that are given to people with bad credit, minimal assets,

    and little or no experience with debt. Because so many banks were giving loans to people that

    had difficulty repaying the bank, a lot of mortgages were defaulted on. This would not have

    happened if banks screened loan applicants properly before lending to them. As shown in the

    following graph, the annual volume of subprime mortgages increased at an alarming rate

    between the years of 2003 and 2005. Subprime mortgages were also a significant percent of the

    mortgage market and therefore the defaults had an enormous impact on the economy. By the

    year 2005, nearly one in every five mortgages was subprime.

    15

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    16/25

    Due to the foreclosures, banks that did a lot of subprime lending acquired a significant

    amount of bad assets. TARP took bad mortgages off of the books of financial institutions in

    America and made them a government responsibility. By removing these bad assets from the

    financial system, TARP made it so that these assets were no longer on banks balance sheets and

    banks could avoid further losses. The government also believed that once these assets began

    being traded again, their prices would increase in value and this would benefit both the banks

    and the Treasury.

    TARP had several goals that it was formulated to achieve. It was created to assist

    financial institutions, encourage banks to increase lending, help banks avoid further losses from

    these bad assets, and address the credit crisis. TARP would address the credit crisis though

    injecting capital into banks that needed it, purchasing bad assets from financial institutions,

    supporting business lending, and helping homeowners. The treasury hoped that all of these

    methods would strengthen the American Economy.

    16

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    17/25

    TARP gave the US Treasury $700 Billion in purchasing power. $250 Billion of this

    amount was accessible immediately. $100 Billion, however, would be accessible with the

    Presidents authorization and the remaining $350 Billion had to have the approval of Congress.

    This money was spent on buying mortgage backed securities and creating liquidity. By

    September 30, 2010 the TARP had disbursed over $388 billion of the $475 billion that was

    finally allocated to the program. The recipients that received the largest parts of this sum were

    AIG, General Motors, Citigroup, and Bank of America.

    Through these capital injections and purchases of toxic assets, TARP encouraged banks

    to increase their lending back to the levels they lent at prior to the economic crisis. Increased

    17

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    18/25

    lending leads to loosened financial markets and eventually increased investor confidence in the

    economy. When purchasing bad assets, however, TARP encountered the issue of how to price

    these assets. It was very difficult to place a value on these assets, especially because the pricing

    must strike a balance between efficiently using public funds provided by the taxpayer and

    providing adequate assistance to the financial institutions that need it (Nothwehr 2).

    This program was ended on September 30, 2010 when Congress decided not to extend it.

    TARP was not as successful as the Treasury hoped it would be and whether it was successful at

    all is debated by economists. TARP was successful in preventing a complete collapse of the

    financial system. Also, credit still remains tight but it is better that it was during the credit

    crunch. In addition to this, TARP was successful in bailing out the banking system and giving

    banks the opportunity to raise capital and increase profits.

    Unfortunately, TARP did not achieve its other goals. Home foreclosures continued and

    many people ended up losing their homes. Also, levels of unemployment were extremely high

    and to this day are very high. Unemployment is currently 9.1%. Supporters of TARP argue that

    without the program, unemployment would be significantly higher.

    One reason that TARP was not as successful as the government intended it to be was

    because it was difficult to keep track of the use of the funds. It gave money to banks to increase

    the amount of loans and give the banks an opportunity to earn profit. TARP, however, failed to

    set regulations regarding the use of this money and instead banks used the funds to protect

    themselves against debt. Also, several banks used this money to acquire other businesses and

    also invest for the future. In addition to that, several banks used the money to pay bonuses to

    their executives.

    18

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    19/25

    Another criticism of TARP is that it privatized profits and socialized losses (Fernando

    1). In other words, the program was fueled by taxpayers, yet they reaped little benefit. However,

    Government has recovered about $192 billion from the repurchase of bank securities by financial

    institutions and earned $30 billion in interest. Most of the institutions that received the largest

    sums of money, have already repaid the government. Due to this, the cost to taxpayers is

    significantly lower than what was originally expected. As of November of 2010, the cost to

    taxpayers was expected to be about $25 billion.

    In conclusion, billions of dollars were injected into the economy as a result of TARP and

    there were little effects on banks lending habits and instead there was a big issue of moral

    hazard in regard of how the funds were used. This money was neither used efficiently nor

    effectively. In defense of TARP, the economy benefited from preventing the collapse of the

    financial system but this could have been prevented in a much more effective manner that would

    lead to more benefits to society.

    19

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    20/25

    Part V: Commercial Paper Funding Facility (CPFF), Term Securities Lending Facility

    (TSLF), and AMLF

    In response to many of the financial issues that the United States faced during the

    subprime mortgage crisis, the Federal Reserve used many tools. Details of these tools are listed

    below:

    Name: The Commercial Paper Funding Facility (CPFF)

    Description: Created in October 2008 to provide a liquidity backstop to U.S. issuers ofcommercial paper. The CPFF was designed to improve liquidity in short-termfunding markets and thereby contribute to greater availability of credit for

    20

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    21/25

    businesses and households. Under the CPFF, the Federal Reserve Bank of NewYork financed the purchase of highly rated unsecured and asset-backedcommercial paper from eligible issuers through eligible primary dealers.

    Result: The facility expired on February 1, 2010.

    (The Federal Reserve)

    Name: The Term Securities Lending Facility (TSLF)

    Description:

    A weekly loan facility that promoted liquidity in Treasury and other collateralmarkets and thus fostered the functioning of financial markets more generally.The program offered Treasury securities held by the System Open MarketAccount (SOMA) for loan over a one-month term against other program-eligiblegeneral collateral. Securities loans were awarded to primary dealers based on acompetitive single-price auction. The TSLF was announced on March 11, 2008,and the first auction was conducted on March 27, 2008.

    Result: The TSLF was closed on February 1, 2010.(The Federal Reserve)

    Name: Asset-Back Commercial Paper

    Description:

    A short-term investment vehicle with a maturity that is typically between 90 and180 days. The security itself is typically issued by a bank or other financialinstitution. The notes are backed by physical assets such as trade receivables, andare generally used for short-term financing needs.

    (The Federal Reserve)

    Name: The Money Market Investor Funding Facility (MMIFF)

    Description:

    A Facility designed to provide liquidity to U.S. money market investors. Underthe MMIFF, the Federal Reserve Bank of New York could provide seniorsecured funding to a series of special purpose vehicles to facilitate an industry-supported private-sector initiative to finance the purchase of eligible assets fromeligible investors.

    Result: The MMIFF expired on October, 20, 2009.

    (The Federal Reserve)

    Name: The Primary Dealer Credit Facility (PDCF)

    Description: An overnight loan facility that provided funding to primary dealers in exchangefor a specified range of eligible collateral and was intended to foster the

    21

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    22/25

    functioning of financial markets more generally. The PDCF began operations onMarch 17, 2008.

    Result: The PDCF was closed on February 1, 2010.

    (The Federal Reserve)

    Name: Term Auction Facility (TAF)

    Description:Through TAF, the Federal Reserve auctioned term funds to depositoryinstitutions. Bids were submitted by phone through local Reserve Banks.

    Result: The final TAF auction was conducted on March 8, 2010.

    (The Federal Reserve)

    Name: Term Asset-Backed Securities Loan Facility (TALF)

    Description:

    TALF was created to help market participants meet the credit needs ofhouseholds and small businesses by supporting the issuance of asset-backedsecurities (ABS) collateralized by auto loans, student loans, credit card loans,equipment loans, floorplan loans, insurance premium finance loans, loansguaranteed by the Small Business Administration, residential mortgage servicingadvances or commercial mortgage loans.

    Result: The facility was closed on March 31, 2010.

    (The Federal Reserve)

    After many of these tools had expired, federal agencies issues The Secure and Fair

    Enforcement for Mortgage Licensing Act:

    Name: The Secure and Fair Enforcement for Mortgage Licensing Act (S.A.F.E Act)

    Description:The S.A.F.E. Act mandates that all employees of banks / credit unions who aremortgage loan originators (MLOs) are federally registered.

    (National Credit Union Administration)

    22

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    23/25

    Works Cited

    Baker, Dean. "The Failures of TARP | Testimony." CEPR. 19 Nov. 2009. Web. 11 Oct. 2011.

    .

    The Bureau of Labor Statistics. The Average Unemployment Civilian Labor Force. Web. 09

    October 2011. http://www.bls.gov/cps/prev_yrs.htm.

    The Conference Board. Leading and Lagging Indicators. Web. 11 October 2009.

    < http://www.conference-board.org/>.

    Derderian, Mara. "Finance 201." Bryant University, Smithfield, RI. Sept. 2011. Lecture.

    23

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    24/25

    Epstein, Lita. "TARP Saved the Banking System, but Failed at Everything Else -

    DailyFinance."Business News, Stock Quotes, Investment Advice - DailyFinance. 20 Nov.

    2009. Web. 5 Oct. 2011. .

    The Federal Reserve.Board of Governors of the Federal Reserve System. Web. 11 Oct. 2011.

    .

    The Federal Reserve. The Panic of 2008. Web. 09 October 2011.

    The Federal Reserve Bank of Dallas. The Rise and Fall of Subprime Mortgages. 09 October

    2011.

    Fernando, Vincent. "TARP Saved The Entire Financial System For Just The Cost Of A Few

    Months At War - Business Insider."Featured Articles From The Business Insider. 04

    Oct. 2010. Web. 5 Oct. 2011. .

    Hong, Nicole. "S&P 500 Closes at Year Low, Nears Bear Market - Market Extra -

    MarketWatch." MarketWatch - Stock Market Quotes, Business News, Financial News.

    Web. 11 Oct. 2011. .

    "Listings Indices."NYSE, New York Stock Exchange. Web. 11 Oct. 2011.

    .

    Mankiw, N. Gregory. "Investment." Macroeconomics. 7th ed. New York: Worth, 2007. Print.

    24

  • 8/3/2019 Economic Indicators - Intermediate Macroeconomics

    25/25

    Montgomery, Lori. "TARP Expected to Cost U.S. Only $25 Billion, CBO Says." The

    Washington Post: National, World & D.C. Area News and Headlines - The Washington

    Post. The Washington Post, 30 Nov. 2010. Web. 5 Oct. 2011.

    Morgenson, Gretchen. "TARP Is Done, but Count on Sequels - NYTimes.com." The New York

    Times - Breaking News, World News & Multimedia. 02 Oct. 2010. Web. 5 Oct. 2011.

    .

    "NASDAQ Composite: INDEXNASDAQ:.IXIC Quotes & News - Google Finance." Google.

    Web. 11 Oct. 2011. .

    National Credit Union Administration (NCUA). "S.A.F.E. Act."National Credit Union

    Administration (NCUA). Web. 11 Oct. 2011.

    .

    Nothwehr, Erin. "Emergency Economic Stabilization Act of 2008 | University of Iowa Center for

    International Finance and Development." The University of Iowa College of Law. Web. 5

    Oct. 2011. .

    "Troubled Asset Relief Program (TARP)." Track the Stimulus. Web. 5 Oct. 2011.

    .

    "Troubled Asset Relief Program (TARP)." Troubled Asset Relief Program (TARP) - the Bailout

    Bill. Web. 5 Oct. 2011. .

    25