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A Precarious Balance:Outlook for the U.S. Economy
Dr. John CaldwellDirector of Economics
Edison Electric Institute
What Constitutes a Recession?
Source: Federal Reserve Board
Interruptions in Long-Run
Growth
The Business Cycle Since WWII
Note: Average annual real GDP growth during this period has been 3.4%.
Causes of RecessionsWhich Was Responsible for This One?
___ Speculative “Bubble”
___ Sudden and/or Extreme Rise in Energy Prices
___ Failure of Regulators/Auditors to Identify Systemic Problems in Business/Accounting Practices
___ Tightening of Money Supply by Central Bank
___ Credit Crisis – Insolvency of Financial Institutions
___ Excessive Reliance on Foreign Sources of Funding
√
√
√
√
√
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The Economic Crisis: Timeline
2000 20051995
1990’s U.S. Stock Market Boom
Asian Financial Crisis
Start of Housing Bubble
“Dot-Com” Recession; Collapse of
Stock Bubble
Energy/Commodity Prices Soar
Start of Current
Recession
Housing Prices Peak
The Financial Meltdown: Timeline of Events
Oil tops $100/bbl
S&P’s/Moody’s downgrade
several hundred subprime bonds &
securities
Fitch downgrades Countrywide to
BBB+Bank of America
buys Countrywide
Bush signs Economic Stimulus
Act of 2008
Northern Rock nationalized
Housing and Economic Recovery
Act of 2008
• Fannie May / Freddie Mack seized by government
• Lehman Brothers files bankruptcy• House rejects bailout plan
Congress approves bailout plan – Bush signs
Barack Obama elected President
Obama signs
stimulus bill
Subprime lender New Century files for bankruptcy
Diminished liquidity in interbank lending markets
JP Morgan buys Bear Stearns
Causes of the Financial Crisis• Abundance of Low-Cost Sources of Money
• Housing Boom Encouraged Consumers to Over-Extend in Borrowing
• Faulty Lending Practices
– Government policy aggressively encouraged expansion of homeownership
– Reward structure in lending based on fees rather than interest income
– Risky loans repackaged into complex investments
– “Capture theory” – Ratings agencies had incentive to give these investments positive evaluations
America’s Growing Reliance Upon Debt
Source: Federal Reserve Board
Recent Trends Indicate A Rise in Both Poverty and Debt
State of the EconomySome Disturbing “Vital Signs”
How Serious is This One? Comparison with Past Recessions
Length (Months)
05101520
Loss of Output
-4%
-3%
-2%
-1%
0%
1%
1929 = 42 months 1929 = 25%
1929 = 27% 1929 = 89%
The National Debt• Currently at $10.8 trillion (78% of GDP, $35,000 per person)
• Why is the National Debt a Problem?– Leads to inflationary pressures / high interest rates
– 25% of it is owed to foreign countries
– Interest expense on debt becomes significant share of government budget
Social Security / MedicareA Huge Bill Looming Ahead
• “Pay as you go” entitlement programs are underfunded:
• Social Security needs an additional $13.6 trillion to meet future needs . . .
• But Medicare needs an additional $85.6 trillion!!!
• How bad is this? Consider some alternative “fixes”:• Bill every American today $330,000 (or $840,000 per household).
• Raise income taxes by 68%.
• Cut government discretionary spending (e.g., national defense, education, the environment) by 97%.
National Debt Will Continue to Grow
Source: Congressional Budget Office
Will reach 85% of GDP in 2010
“Follow the Money”Why Government Spending Is
Not a Long-Term Solution
Private Sector Investment
Government Spending
Private Savings
Taxes
Foreign Investment(from Trade Deficit)
$
$
$
$
$$
$
$
$
$
Prognosis for the EconomyWhen Can We Expect a Recovery?
• Necessary Preconditions for Recovery:• Housing Prices Bottom Out• Borrowing / Spending Resumed• Consumer Confidence Restored• Banks’ “Toxic” Assets Eliminated/Managed
• Potential Roadblocks to Recovery:• Second Banking Crisis • Stimulus Program Has No Effect
• Too Little, Too Late, or Channeled into Wrong Areas• Trade Wars Due to Protectionist Elements in Plan(s)
• Financial Sector Restructuring Ineffective
The Road to RecoveryThe Long View
• Borrowing and Lending
• Consumer Spending
• Full Employment
• Remove “Toxic Assets”
• New Regulation of Financial System
• Rein in Deficit Spending
• Reduce National Debt
Businesses / Consumers Banking / Financial Sector Federal Government
Thank You!