TheGreatRecession:EarthquakeforMacroeconomics

LawrenceJ.ChristianoFreie Universitat Berlin,May30,2016

Objective• DiscusstheGreatRecession,2007-?

• Whatcausedit,whatmadeitlastsolong?

• Whydidsofewpeople(includingmacroeconomists)predictit?

• WhatimpactisithavingonMacroeconomicsasadiscipline?

• Macroeconomics

• Thebranchofeconomicsconcernedwithunderstandingthebehavioroftheeconomyasawhole.

• Principlefocus:periodicupsanddownsinaggregateeconomicactivity.• Business cycles

GreatRecession• Big,bypostWorldWarIIstandards.

The 2007-2009 Recession in PerspectiveOutput Consumption Investment Employment Hours

Percentage change, peak to trough2007-2009 Recession (2007 Q4-2009 Q3) -7.2 -5.4 -33.5 -6.7 -8.7Average Post WWII Recessions -4.4 -2.1 -17.8 -3.8 -3.2US Great Depression (1929 to 1933) -36 -23 -69 -27Christiano-Motto-Rostagno (2003)

SmallerthanGreatDepression.

GreatRecession

• AlthoughtheNBERbusinesscyclecommitteedeclaredtherecessionoverinsummer2009,notclearthatitreallystoppedthen.

GDPperperson(adjustedforinflation)

MoreEvidencethatWe’renotReallyoutoftheWoodsYet:LaborMarket

SuddenplungeinGreatRecessionwithslowandincompleterecovery.

Feb.2016

Civiliannon-institutionalpopulation in2016:253million.

Whythe5percentagepoint(i.e.,12millionpeople)plungeinemployment?Whyonlya1.5percentagepointriserecently?

E

Jan.2013

Accelerationindeclineat‘end’ofGreatRecession

Demographics?

Labormarket…unemployment• Categories:

• Laborforce,L=E+U

• Employed,E.• Unemployed(lookingforwork,buthaven’tfoundjob),U.

• Unemploymentrate:u=U/L=1– E/L.

• ImeasureL,E,U relativetopopulation.

• E.g.,E is‘employmenttopopulationratio’.

Unemploymentrate:thistimeitwasdifferent

• Traditionally,theunemploymentrateisusedasameasureofthehealthofthelabormarket.

• Historically,whenu falls,it’sanindicatorthatmorepeoplearebeingputtowork,i.e.,E isincreasing.

u=1– E/L

Declineinu primarilyreflectedfallinL!

Unemploymentrate

• Recentdropinunemploymentnot primarilyanindicatorofimprovedfunctioninginthelabormarket.

• Anotherworrisomefeatureoflabormarket:unemploymentduration.

• AskeachpersoninU,‘howlonghaveyoubeenunemployed?’

• Computeaverageoverallanswerstothequestion:

Meandurationofunemployment.

Theamountoftimespentunemployedisgreater,byfar,thanithasbeenatanypointinthepast70years.

Questions• WhatwasthetriggerfortheGreatRecession?

• Whatmadeitlastsolong?

• Avarietyofhypotheseswereadvanced.

• Nowaconsensusseemstobetakingshape.

• Butfirst,

• discusssomeideasthatwereadvancedinitially,butseemlessappealingnow.

InitialResponses• Initially,therewasmuchpuzzlementoverwhatwashappening(moreonthislater).

• Acoupleofinitialanswers:

• Firmshavelotsofjobopenings,it’sjustthatworkersdon’thavetherightqualifications.Skillsmismatchhypothesis.

• Firmshesitatetohiremoreworkersbecausetheyareuncertainaboutfuturetaxesandregulations.Uncertaintyhypothesis.

PresidentofFederalReserveBankofMinneapolis,on‘MismatchHypothesis’(8/17/2010)

• “Firmshavejobs,butcan’tfindappropriateworkers.Theworkerswanttowork,butcan’tfindappropriatejobs.”

• “Whateverthesource[ofthismismatch]itishardtoseehowtheFedcandomuchtocurethisproblem.”

• “Mostoftheexistingunemploymentrepresentsmismatchthatisnotreadilyamenabletomonetarypolicy.”

Source:https://www.minneapolisfed.org/news-and-events/presidents-speeches/inside-the-fomc#_ftnref2

MismatchHypothesisDoesNotHoldupinData

• Majorproblemforthemismatchhypothesis:

• All typesofworkersarehavingdifficultyfindingwork:

• Unemploymentratejumpedforworkersofdifferentoccupationsandeducationlevels.

• Source:HeidiShierholz:http://www.epi.org/publication/shortage-skilled-workers/

Unemploymentratehigherforworkersatalleducationlevels.Nearlydoublesforhighereducationlevels.

MismatchHypothesisDoesNotHoldupinData

• Ifthereasonfirmsarenothiringisthattheycan’tfindtherightworkers,thentheworkerstheydo haveshouldbeworkingharder.

• But,hoursworkedisdownacrossalmostallindustries.

Averagingacrossallworkers,wealsoseenoevidenceofanincreaseinaverageweeklyhoursrelativetobeforethestartoftherecession.

MismatchHypothesisDoesNotHoldupinData

• Ifwhat’sholdingfirmsbackfromhiringistheinabilitytofindtherighttypeofworkers,thenthewageofsometypesofworkers(the‘righttypes’)shouldbeskyrocketing.

• But,wagesacrosslotsofoccupationsarerisingatprettymodestrates.

Amountbywhichtheaverageworker’soutputincreasedfrom2007to2012

Moreproblemswithmismatch

• Ifskillsrequiredforworkincreasedsubstantially,shouldseeitinthelaborproductivitydata.

• Thepeoplethatareworkingshouldbeespeciallyproductive.

• Don’tseethisinthedata.

OverallrecenttrendinlaborProductivitygrowthseemsdown.

JobOpeningsandLaborTurnoverSurvey

• MuchofthemotivationforskillsmismatchcamefromJOLTSdata.

• Mylate2012,vacancyratewasbacktowhereitwasbeforerecession,butunemploymentratewasstillhigh.

• Seemedlikethejobswerethere,it’sjustthattheAmericanworkerwasnolongerqualified.

• (Blamethevictim?)

September,2009

September,2012

JOLTSdatanotconvincing

• PeoplesoonrememberedthatobservedcounterclockwiserotationinBeveridgecurveisexactlywhattheorypredictsinamajorrecession.

• Doesnotimplyanymismatch.

• ObservationmadebyPissarides longago.

• Quantitativediscussion:Christiano-Eichenbaum-Trabandt,‘UnderstandingtheGreatRecession’

MismatchHypothesisDoesNotHoldupinData

• Anotherwaytotestmismatchhypothesis:

• Ask firms!

• Sincetheearly1970s,theNationalFederationofIndependentBusiness,asmallbusinessassociation,hassurveyeditsmemberstofindoutwhattheir‘topproblemis’.

• Theyareaskedtoselectfromamongthefollowing10categories:

• Taxes,Inflation,Poorsales,Finance&interestrates,Costoflabor,Governmentregulations&redtape,Competitionfromlargebusinesses,Qualityoflabor,Cost/availabilityofinsurance,Other.

Poorsaleshasbeenthebigproblem,not qualityoflabor.

FortheNFIBsurvey, firmsweregivenalistof10possible ‘singlemostimportantproblems’.Thenumbersinthechartreport thepercentoffirmslistingtheindicatedproblemasthemostimportant.Thechartreportsresults foronlyfourofthe10possible candidatesforthe‘singlemostimportantproblem’.Theothersixpossibleproblemswerechosen lessoftenthan‘poorsales’ .Seehttp://www.nfib.com/Portals/0/PDF/sbet/sbet201502.pdf

AnotherHypothesis:BadGovernment

• Policyuncertaintyandtoomuchregulation*.

• Baker,BloomandDavisconstructameasureofeconomicpolicyuncertainty.

• Theirindicatorcamedowntopre-recessionlevelsbyNovember2012• Nobigpickupinemploymentafterthat,suggestingthatwasnotamajorfactorholdingfirmsback.

*See:http://www.minneapolisfed.org/research/wp/wp694.pdf

Source:http://www.policyuncertainty.com/

August2011,debtceilingdispute

October2010,midtermelections

Jan.2013

Gov’tshutdownanddebtceilingSeptember2013

Summarysofar• TheGreatRecessionisindeedGreat

• Mismatch,uncertaintyandbadgovernmentpolicyhypotheses• seemunlikelyeitherasamajorcauseorsourceofpropagationoftheGreatRecession.

• IhavenotmentionedtheideathattheFedcausedtheGreatRecessionbykeepinginterestratestoolowinthepre-2007period.• Thishypothesisalsoseemsnottocommandmuchagreement.• See,e.g.,Bernanke(http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/28-taylor-rule-monetary-policy)fordiscussion.

• Thebehavioroflaborforceparticipationispuzzling,anddeservesgreaterattention.• See,e.g.,Christiano-Eichenbaum-Trabandt,AEJM,2015.

• Bottomline:GreatRecessionlookslikeaclassicdemand-shock recession.• Lowoutputandlowinflation.• But,whatisthesourceofthedemandshock???

TheBigQuestionsRemain

• WhatcausedGreatRecession,whyhasitlastedsolong?

• Whydidfewpeople(includingmacroeconomists)predictit?

• WhatimpactisithavingonMacroeconomicsasadiscipline?

SketchofEmergingConventionalWisdom• ImmediateCauseofGreatRecession:

• Aclassic19th century-stylerunontheUSbankingsystem(Gorton).• Therunwastriggeredbythecollapseofthehousingbubble.• Damagetofinancialsystemcontributedtocollapseininvestmentspending.

• Thebankingcrisiswasoverbytheendof2009.Whydidtherecessioncontinue?• Asubstantialnumberofhouseholdsfeltverypoorbecauseofthereductioninhouseprices.

• Thesehouseholdschosetocutbackonconsumptioninthehopeofincreasingsaving(Mian andSufi).

• ThebindingzerolowerboundontheinterestratetransformedthereductionsinconsumptionandinvestmentintoadropinGDP.• Withabigenoughfallintheinterestrate,employmentandGDPcouldhavebeeninsulatedfromtheshockstoconsumptionandinvestment.

Thisiswhatabankrunlookedlikehistorically.

Thistime,bankrunswereinvisibletomostpeople(Gorton).

TheDramaoftheBankRunsBroughttoLifeinSomeGreatMovies!

BankingCrisis,the‘ThePanicof2007’(Gorton)• Whatisabank?

• Borrowsshortrunandlendslongrun(‘maturitymismatch’)

• Example:• banktakesa$1depositandpromisestorepay$1inoneperiod.• Itlendsthemoneytoafirm,whichpromisestopaythe$1backintwo periods(zerointerest!)

• Thebankobviouslycannotinfactrepaythedepositinoneperiod.• Itcountsonthedepositor‘rollingover’theloanafteroneperiod.• Alternatively,thebankmustfindanotherlenderifthefirstlenderdoesn’twanttorollover.• Bank‘run’:whenabankcannotrolloveradepositorfindanotherlender.

• Whymightabankrunoccur?• Depositorsknowthatifbankcannotgetfunding,thenthebankmustsellloanataloss.• Inthatcase,depositorscannotgetalltheirmoneyback.• Thus,ifdepositorsthinktherewillbearun,it’sintheirinteresttorunnow:CRISIS!

But,howcantherebeabankrunwhenthereisdepositinsurance?

• Thedepositsofcommercialbanksareinsured.• Asaresult,thereisneverarunonacommercialbank.

• TherunsoccurredintheShadowBankingSystem.

• Asthenamesuggests,theshadowbankingsystemislivingintheshadows.

• Dataonfinancialfirmsisabyproductofregulation.• Shadowbankslightlyregulatedandsonotmuchwasknownaboutthem.• Littlewasknownaboutthembypoliticians,journalists,academicsandevenpolicymakers.

Howandwhydidtheshadowbankingsystemcomeintoexistence?• ShadowbankswereawaytoavoidregulationwhilemaintainingsomeprotectionfromtheFed.

• Federalreservepolicymakerssortofknewabouttheexistenceoftheshadowbanks,buttheylookedtheotherway.

• Thiswasinpartbecauseoftheprevailingmoodofthetime,thatregulationstiflescreativity.

• FedChairmanGreenspanfamouslybelievedinthepoweroffinancialmarketstoregulatethemselves.Later,herecanted(seehttp://www.nytimes.com/2008/10/24/business/economy/24panel.html)

• Thepreferenceoftheshadowbankingsystemformortgagesecuritiesdovetailedwithpoliticalprioritiesthatfavoredgettinglowincomehouseholdsintohousing(Rajan).

ExampleofaShadowBank:AStructuredInvestmentVehicle(SIV)• Supposeacommercialbankmakesamortgageloanof$100tosomeone.Thisiscalledaloanorigination.

• Longago,themortgagewouldhavestayedonthecommercialbank’sbooks.

• BeforethecrisistheywouldsellawholeportfolioofmortgagestoanSIV.

• TheSIVwouldpayforthemortgagesbyissuingshort-termsecurities,whichpeopleboughtthinkingtheywereriskfree.

• Asset-backedsecurities(ABS),asset-backedcommercialpaper(ABCP).• SIV’smadehugeprofitsbecausetheyhadanimplicitpromisefromoriginatingbanktobuybackthemortgagesincasetheywentbad.

• ThepromisewascrediblebecausetheoriginatingbankhadtheFedstandingbehinditincaseoftrouble.

ThePanicof2007• Housingpricesbegantosoftenandthenfallin2006.

• Therewasarealconcernthatso-calledsubprimemortgageswouldgobad.• Policymakerswererelativelyunconcernedbecausesubprimes totalled only$1trillion.• Whatnooneappreciatedwasthesizeoftheshadowbankingsystemanditsvulnerabilitytoruns.

• Holdersofasset-backedcommercialpaper(ABCP)becameskittish.• MucheasiertowithdrawfundsthantocarefullydeterminethesafetyoftheABCP.

• July30,2007aGermanbank,IKB,announcedthatitrequiredemergencyfunding.

• Problem:itsoff-balance-sheetvehicle(‘Rhineland’)wasnotabletorollovertheasset-backedcommercialpaper(ABCP)ithadbeenissuinginUSmarketstofunditslargeportfolioofUSmortgages.

• AlthoughnoneofthemortgagesintheRhinelandportfoliowasindefaultandonlysomeweresubprime-related,Rhinelandcreditorsdecidednottoroll.

• ThiscreatedacrisisforIKBbecauseitsreputationwouldsufferifitdidn’tstandbyRhineland.

July,2007

IssuanceofABCPabruptlystoppedinsummer,2007,aspartofthebankrun.

DANIELCOVITZ,NELLIELIANG,andGUSTAVOA.SUAREZ,TheEvolutionofaFinancialCrisis:CollapseoftheAsset-BackedCommercialPaperMarket,THEJOURNALOFFINANCE•VOL.LXVIII,NO.3•JUNE2013

Wheredidallthemoneycomefrom?

• Theshadowbankingsystemexpandedalotmorethananyoneknewatthetime.

• Itwasgettingalotofmoneyfromsomebody.• Fromwho?CertainlynotonlyfromAmericans.• Answer:GlobalSavingsGlut(Bernanke).

• Whywassomuchgoingintomortgages?• Suggestedanswer:BankingGlut(HyunShin).

Americanshavebeenabsorbingmoregoodsthantheyproduceformanyyears.

USCurrentAccountDeficit

• Americansarenetimportersofgoods.

• Balanceofpayments:

•Netimportsofgoodsequalsnetexportsoffinancialclaims.

• WhichcountriesisAmericaexportingfinancialclaimsto?

GrowingUScurrentaccountdeficitprimarilyagainstAsiaandOilExporters.

Whythebigimbalances?

• Hypothesis#1:Americansaregreedyandlazy.• Theyconsumemorethantheyproduce,sendIOU’stoforeigners.• Currentaccountdrivesthefinancialaccount.

• Hypothesis#2(SavingsGlut):ForeignersarehungryforUSfinancialassets.• Financialaccountdrivesthecurrentaccount.

• SimpleMundell-Flemingreasoningbehindhypothesis#2.• ForeignersloveUSassets,sotheybuytheminlargenumbers.• Causesdollarover-valuation,drivingUStradebalanceintodeficit.• USinterestratesdropasassetpricesbidupbyforeigners.

• Hypothesis#1impliesUSinterestratesriseasgreedyAmericanstrytoinducepeopletolendtothem.

Hypothesis#2(SavingsGlutHypothesis)winsbyawidemargin.

Source:Justiniano, Primiceri andTambalotti (2015),“TheEffectsoftheSavingandBankingGlutontheUSEconomy”.

Whydidsomuchmoneygointomortgages?• OneanswersuggestedbyHyunShinandothers.

• RecallthattheEuroAreacurrentaccountisroughlybalanced.• Onnet,financialflowsbetweentheUSandEAbalanced.

• But,thegrossflowsbetweenUSandEAarehugeandofaparticulartype.

• Inparticular,EuropeanbankshavebeenbuyingmortgagesinUSfinancialmarketsandfinancingthembyissuingABCPintheUSmarkets.

• RecallRhinelandandIKB.

Source:Justiniano, Primiceri andTambalotti (2015),“TheEffectsoftheSavingandBankingGlutontheUSEconomy”.

ConsistentwithideathathousingpurchasesbeingfundedbyInflowofforeigncapitalcorrespondingtocurrentaccountdeficit.

Houseprices

Currentaccount

SummaryofAnalysissoFar• Theanalysisjustdescribedbearsastrongsimilaritytoanalysesofemergingmarketcrisesin1990sandearlier.

• Foreignersgetallexcitedaboutagroupofemergingmarketeconomies.• Financialcapitalpoursintothateconomy.• Bigcurrentaccountdeficit.• Regulatorycontrolsbreakdown.• Stuffgoeswrong.• Foreignersrunaway,leavingthecountryinashambles(suddenstop).

• Therearesome differences.• America’sobligationsdenominatedindollars(nocurrencymismatchissues).• Nosuddenstop,nocurrencycrisis.• NoUSgovernmentdebtcrisis(indeed,iftherewasacrisisitwasthatthereistoolittle USgovernmentdebttosatisfyworlddemand).

Bankingcrisisisnotthewholestory.

Crisisappearstobeoverbysummer,2009,buteconomyremainsweakforyears.

Restofthestory

• Weakconsumptionbyhomeownersthatfeltpoorasaresultofdropinhousevalues.

• Theyhadboughttheirhousefortworeasons:• Niceplacetolive• Plannedtosellitwhenold,andthendownsizeandusethecapitalgainstoretire.• Part2oftheplandiedwiththehousingbust,sohouseholdshadtostartsaving.

Source:Mian andSufi, http://houseofdebt.org/2014/08/08/more-evidence-supporting-the-house-of-debt.html

Mian andSuficross-stateevidencethatfallinhousevalueledtocutbacksinspending.

ZeroLowerBound• JustbecauseonegroupofpeoplecutsbackonspendingdoesnotmeanyouhavetohaveaGreatRecession.

• Inawell-functioningmarketeconomy,interestrateshoulddroptoencouragesomeoneelsetospend.

• Ifsomeoneelsedoesnotexpandspending,arecessionwilloccur.

•GDP=C+I+G+NX• Thefactthattheinterestratehitthezerobound,preventedtheoperationofthishealingforce.

TheZeroLowerBoundIdea

Saving

Investment

LoanableFunds

R

0

‘Normaltimes’

TheZeroLowerBoundIdea

Saving

Investment

LoanableFunds

R

0

Crisis:loanmarketclearingrequires(impossible) negativeinterestrate.ClearingbroughtaboutbyfallinGDP,whichreducessavingforconsumption-smoothing reasons.

Whydidsofew(includingmacroeconomists)predicttheGreatRecession?• Noonewaspayingattentiontotheshadowbankingsystem.

• MostpeoplethoughtintermediationwentthroughthecommercialbanksregulatedbytheFed,orthroughordinarybondandequitymarkets.

• This‘normal’financialsystemseemedperfectlysafe.

• InthePanicof2007,mostpeoplehadneverheardofthemarketsthatwereinvolved.

• The‘shadowbankingsystem’wasnotonanyone’sradar.• EvensomeoneasastuteasBenBernankeacknowledgesthathevastlyunderestimatedthesystemicrisksposedbytheshadowbankingsystem.

ImplicationsforMacroeconomics

• TheGreatRecessionwasaconsequenceofamassivedemandshock.• Nothinghappenedtothesupplysideoftheeconomy.• Shocktoinvestment(residentialandnon-residential)andconsumption.• Weneedaframeworkinwhichdemandshockshaverealeffects.

• Becauseofthis,the(New)Keynesianmodelhascomeroaringbackinpopularity• Withstickyprices,demandshockscanhaveabigeffect,particularlyifthezerolowerboundbecomesbinding.

• But,theNewKeynesianmodelneedsfleshingout.• Fortunately,itisanexcellentplatformtobuildon.

What’stobedone?• ThelabormarketsideoftheNKmodelneedsimprovement.

• AnimportantpolicydebateeruptedduringtheGreatRecession:• Shouldweextendunemploymentbenefits?• Willtheymaketherecessionmoreseverebysubsidizingunemployment?• Or,willtheyhavenoeffectonemploymentandjustmakethelifeofunemployedpeoplemorebearable?

• TheNKmodelcannotaddressthispolicyquestion,butadvancesarebeingmadethatwillallowthemodeltodoso(seeChristiano-Eichenbaum-Trabandt,Econometrica,forthcoming!).

• LaborforceparticipationmovedinananomalouswayduringtheGreatRecession.• Needmodelsthatcanaddressthis.• Theseareunderconstruction(Christiano-Eichenbaum-TrabandtAEJM2015paper).

FinancialSideoftheNKModel

• Anumberofchallengespresentthemselves.

• Needamodelofthebankingsystemthatincorporatestheshadowbankingsystemandbankruns(see,e.g.,Gertler-Kiyotaki-Prestipino 2015).

• Usethemodeltocontemplatemacroprudentialpolicy.• Quantifytrade-offsbetweenriskinessandefficiencyofthebankingsystem.

• TheFedandTreasuryundertookvariouspoliciesthatseemedtoproducegoodresults(atleast,wedidn’thaveasecondGreatDepression!)• TheFedreplacedpartoftheprivateintermediationsystembyacquiringmassiveamountsofprivateassets.

• Muchprogresshasbeenmadeindevelopingmodelsthatcanbeusedtothinkaboutthis(Gertler-Kiyotaki,Christiano-Ikeda,2013,2014).

TheFuture• Integratingfinanceandlabormarketfrictionsintodynamicmodelsrequireswholenewkindsoftraining.

• Finance- mustmasterthevarioustypesofagencyproblemsinintermediation• Adverseselection, hiddeneffort,asymmetricinformationandcostlyverification,runningaway.

• Labormarkets– thelaborliteratureishugeandexplodingaswespeak.• Bargaining,dynamicmodelsofinsurance….hardstuff.Lotstobefoundinthelaborliterature.

• WhatIseeinmacroseminarsandconferencesinrecentyearsiscompletelydifferentfromwhatIsawbeforethecrisis.• Thedifferenceissobig,itfeelsasthoughwe’veallbeenstruckbyanearthquake.• Hence,thetitleformypresentation.

Thebigpicture?• Arguably,macroeconomicswasborninthe1930s,inthehorroroftheGreatDepression.• Thatiswhenthenationalincomeandproductaccounts(NIPA)weredeveloped.

• KeynesianeconomicswasorganizedaroundtheNIPAaccounts.• It’savisionunderwhichmarketeconomiesworkprettywellmuchofthetime.• But,sometimestheycanlapseintodysfunction,whengovernmentinterventionmaybehelpful.

• Thehistorysincethe1930s,particularlywiththerationalexpectationsrevolution,isoneofconstantlyimprovingthemicrofoundationsoftheframeworkinitiallysketchedbyKeynes.• Amacroeconomyhaslotsofmovingparts.• Microfoundationsverifiesthattheyareallmovingtogethersensibly.

• Inrecentyears,thatframeworkenteredanothergrowthspurt.