The Long Slump Robert Hall Stanford American Economic Association - PowerPoint PPT Presentation

The Long Slump Robert Hall Stanford American Economic Association Presidential Address January 8, 2011 · 1

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The message Overhang of housing and consumer durables 3

The message Overhang of housing and consumer durables High consumer commitments to debt service 4

The message Overhang of housing and consumer durables High consumer commitments to debt service Financial friction 5

The message Overhang of housing and consumer durables An economy unable High consumer to low er its interest commitments to + rate to generate debt service alternative spending Financial friction 6

The message Overhang of The Long Slump housing and consumer durables 12 Unemployment 10 An economy unable High consumer 8 to low er its interest commitments to + = Long slump rate to generate 6 debt service alternative spending 4 2007 2015 Actual and CBO forecast 2 Financial friction 7

The problem Normal demand function Supply 12 function 8 Normal employment and t rate normal interest rate 4 Interest 0 0 ‐ 4 4 ‐ 8 8 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 Employment 8

September 15, 2008 9 ·

The problem Normal demand function Supply 12 function 8 Normal employment and t rate Crisis normal interest rate 4 Interest Crisis demand function 0 0 Normal employment and ‐ 4 4 low crisis interest rate l i i i ‐ 8 8 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 Employment 10

The problem Normal demand function Supply 12 function 8 Normal employment and t rate Crisis normal interest rate 4 Interest Crisis demand function 0 0 ‐ 2.5 5 Normal employment and Normal employment and ‐ 4 ‐ 4 low crisis interest rate ‐ 8 8 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 Employment 11

The interest rate fails to do its job Supply 12 function 8 Crisis demand function t rate Excess 4 Interest supply Interest rate pinned at zero 0 0 ‐ 4 4 ‐ 8 8 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 Employment 12

Literature Krugman (1998,2010), Eggertsson-Woodford (2003) and Eggertsson (2001-2010), Christiano-Eichenbaum-Rebelo (2010) · 13

Ratios of capital and durables to GDP 1.8 Housing and 1.6 consumer durables 1.4 1.2 1.0 Business capital B i i l 0.8 0.6 0.4 0.2 0.0 1990 1995 2000 2005 14

Households at a Corner Solution in Intertemporal Trade In the 2007 Survey of Consumer Finances, 58 percent of consumption occurs in households with less than 2 months of net liquid financial assets · 15

Calculating debt service s t = r D,t − 1 D t − 1 − ∆ D t · 16

Burden of Debt Service, as a Fraction of GDP 0.16 0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00 ‐ 0.02 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 17

Spread, in Percentage Points, between Business Loan Rates and Banks’ Borrowing Rate 3.5 3.0 , percentage points 2.5 2.0 1.5 Spread 1.0 0.5 0.0 2000 2002 2004 2006 2008 2010 18

Spread, in Percentage Points, between Credit-Card Rates and Banks’ Borrowing Rate 16 14 12 , percentage points 10 8 6 6 Spread 4 2 0 2000 2002 2004 2006 2008 2010 19

Spread, in Percentage Points, between Mortgage Rates and 10-year Treasurys 3.5 3.0 d, percentage points 2.5 2.0 1.5 Spread 1.0 0.5 0.0 2000 2002 2004 2006 2008 2010 20

Indexes of Lending Standards Inferred from the FRB Senior Loan Officer Survey 6 Mortgages 5 4 3 3 2 1 Credit cards 0 ‐ 1 Business loans ‐ 2 ‐ 3 ‐ 4 2003 2005 2007 2009 21

Google Searches for “withdrawal penalty” 80 70 70 60 50 40 30 30 20 10 0 2004 2005 2006 2007 2008 2009 2010 22

The nominal interest rate cannot fall below zero Currency is a safe asset paying zero. 23

The nominal interest rate cannot fall below zero Currency is a safe asset paying zero. The Fed will always pay out currency in exchange for reserves. 23

The nominal interest rate cannot fall below zero Currency is a safe asset paying zero. The Fed will always pay out currency in exchange for reserves. If the market return for a bond fell below zero, the owner could sell it, convert the proceeds to currency, and earn a safe higher return. 23

The nominal interest rate cannot fall below zero Currency is a safe asset paying zero. The Fed will always pay out currency in exchange for reserves. If the market return for a bond fell below zero, the owner could sell it, convert the proceeds to currency, and earn a safe higher return. Thus market prices of bonds would fall so that their returns rose to zero. · 23

A long period with nominal short rate pinned at zero 6.0 CBO forecast Actual 5.0 per year 4.0 , percent 3.0 Rate, 2.0 1.0 0.0 2008 2009 2010 2011 2012 2013 2014 2015 24

The real interest rate The real rate is the return measured in output units available from a one-period investment at the safe nominal rate: r t = r n,t − p t +1 − p t , p t where p is the dollar price of output. 25

The real interest rate The real rate is the return measured in output units available from a one-period investment at the safe nominal rate: r t = r n,t − p t +1 − p t , p t where p is the dollar price of output. The real rate is a basic price that clears the current labor and output markets. · 25

Pinned real rate? If the nominal rate is pinned at zero ( r n = 0 ), the real rate is minus the rate of inflation: r t = − p t +1 − p t p t 26

Pinned real rate? If the nominal rate is pinned at zero ( r n = 0 ), the real rate is minus the rate of inflation: r t = − p t +1 − p t p t If the rate of inflation is exogenous, the real rate is pinned at minus the rate of inflation. · 26

The near-exogeneity of inflation in today’s economy 12 10 8 Unemployment rate 6 4 2 One ‐ year ‐ ahead inflation forecast 0 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 27

Fisher diagram of two-period equilibrium 0.75 0.70 Indifference mption in second period curve 0.65 0.60 0.55 Consum 0.50 0.45 0.40 0.40 0.45 0.50 0.55 0.60 0.65 Consumption in first period 28

Fisher diagram of two-period equilibrium 0.75 0.70 Indifference mption in second period curve 0.65 Isoquant 0.60 0.55 Standard Standard Consum equilibrium 0.50 0.45 0.40 0.40 0.45 0.50 0.55 0.60 0.65 Consumption in first period 29

Fisher diagram of two-period equilibrium 0.75 0.70 Indifference mption in second period curve 0.65 Isoquant 0.60 0.55 Standard Standard Consum equilibrium 0.50 0.45 Equilibrium interest rate 0.40 0.40 0.45 0.50 0.55 0.60 0.65 Consumption in first period 30

Fisher diagram of two-period equilibrium 0.75 0 70 0.70 Indifference period curve 0.65 second p Trade to a better point by holding Isoquant 0.60 cash which earns more than the mption in equilibrium rate 0.55 Standard Standard Consum equilibrium 0.50 0.45 Equilibrium interest rate 0.40 0.40 0.45 0.50 0.55 0.60 0.65 Consumption in first period 31

Fisher diagram of two-period equilibrium 0.75 Superior indifference curve Superior indifference curve 0.70 Indifference period curve 0.65 second p Isoquant Trade to a higher indifference 0.60 curve by holding cash earning mption in s above the equilibrium rate 0.55 Standard Consum equilibrium 0.50 0.45 Equilibrium interest rate 0.40 0.40 0.45 0.50 0.55 0.60 0.65 Consumption in first period 32

Two-period equilibrium with pinned interest rate 0.70 0.65 period second p 0.60 Standard equilibrium without high return on currency high return on currency mption in 0.55 Consum 0.50 0.45 0.40 0.40 0.45 0.50 0.55 0.60 0.65 Consumption in first period 33

Two-period equilibrium with pinned interest rate 0.70 0.65 period second p 0.60 Standard equilibrium without mption in s high return on currency high return on currency 0.55 Low ‐ employment equilibrium with high return to currency with high return to currency Consum 0.50 0.45 0.40 0.40 0.45 0.50 0.55 0.60 0.65 Consumption in first period 34

Two-period equilibrium with pinned interest rate 0.70 0.65 Slope = period real return on on second p 0.60 currency Standard equilibrium without high return on currency high return on currency mption in 0.55 Low ‐ employment equilibrium with high return on currency with high return on currency Consum 0.50 0.45 0.40 0.40 0.45 0.50 0.55 0.60 0.65 Consumption in first period 35

Dynamic equilibrium Solow model 36

Dynamic equilibrium Solow model Life-cycle consumption 36

Dynamic equilibrium Solow model Life-cycle consumption Inelastic labor supply 36

Dynamic equilibrium Solow model Life-cycle consumption Inelastic labor supply Capital utilization proportional to employment · 36

Dynamic equilibrium, continued Stock of houses and consumer durables as well as business capital, with adjustment cost for both kinds of capital 37

Dynamic equilibrium, continued Stock of houses and consumer durables as well as business capital, with adjustment cost for both kinds of capital Diamond-Mortensen-Pissarides labor market 37