Effective Measures Against the Recession
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Transcript of Effective Measures Against the Recession
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Effective Measures Against the Recession
Edward C. PrescottJuly 6, 2009
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U.S. Long‐Run Picture
• Relatively steady growth over the last 150 years
• Some fluctuations about trend (HP filtered)
Source of following pictures is Robert E. Lucas, Jr.
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Deviations From Trend
• Relative to trend, GDP lost 40% between 1929 and 1933
• Recently the loss has been about 5%, and most of this is in 2008‐IV and 2009‐I
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How Bad Are Things?
Not that bad, so far
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Contractions (Recessions)
• Recession is not an economic concept
• An economy can’t be in one or not in one
• Prior to development of modern macro, it was not a well‐defined empirical concept
• It was totally discredited by Nobel Laureate T. J. Koopmans in his devastating critique of Burns and Mitchell (the NBER definitions) as measurement without theory
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Sensible Definition of a Contraction
• Any sensible definition corrects for population and trend growth
• A flat line is neither losing nor gaining ground relative to the industrial leaders
• A flat line means living standards double every generation
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Detrended GDP per Person 16‐64 1959‐I to 2009‐I
90
95
100
105
110
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
* Quarterly trend growth: 0.45%
Period Average = 100
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Now There Is Hard Theory
• Given productivity, population, and taxes:
– Predicted and actual paths of the aggregate variables coincide
– All using dynamic economic theory to construct models consistent with national account and other data find same thing
– We find monetary policy had little consequence
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Contractions: Detrended GDPper Person 16‐64 1959‐I to 2009‐I
90
95
100
105
110
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
* Quarterly trend growth: 0.45%
Period Average = 100
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Contractions
• Biggest contraction was 11.2% from 1978‐IV to 1982‐IV
– First two years of it, money was loose– low real interest rate
– Last two years and beyond, money was tight
• The contraction beginning in 1999‐IV was bigger than figure indicates because
– There was a huge amount of unmeasured investment in the second half of the 1990s
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Expansions
• Big expansion of early 1960s was technology driven
• The 1995‐2000 expansion was technology driven
– And in fact was significantly bigger and longer than standard statistics indicate
– Reason: Huge unmeasured intangible investment (R&D, launching new products)
• The second biggest and the longest expansion was in the 1980s and was due to cuts in marginal tax rates
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Expansions: Detrended GDP per Person 16‐64 1959‐I to 2009‐I
90
95
100
105
110
1959-I 1965-I 1971-I 1977-I 1983-I 1989-I 1995-I 2001-I 2007-I
* Quarterly trend growth: 0.45%
Period Average = 100
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What Depressed the U.S. Economy in 2008‐IV and 2009‐I?
• Fed did what it should given the situation– Big increase in reserves
• Fed is not the cause of the recent drop in U.S. GDP (4.0% trend corrected and probably another 1.0% this quarter)
• Not the financial crisis
• Not lack of borrowing
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Liabilities of Households and of their Nonfinancial Businesses
End 2007 End 2008
Total Liabilities (billions $) 31,875 32,341
Composition Share
Mortgages 44.9% 44.4%
Other Loans 18.0% 18.5%
Corporate Bonds 11.2% 12.0%
Security credit 1.0% 0.5%Trade payable 8.2% 8.5%
Other 16.8% 16.1%
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Then What Depressed the U.S. Economy in 2008‐IV and 2009‐I‐II?
• Fact: Investment became depressed
• There are 25 million small businesses in the U.S. – 5 million of them have employees
• Their owners feared higher tax rates
– Rationally cut investment
– Rationally cut employment
– Took more cash out of business
• Workers fearing job loss rationally cut auto buying
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Fears Are Being Realized
• Tax rates are being increased
• These increases lower amount of capital a firms chooses to have
• Reason for low investment is not problem of getting loans – it is expected high tax rates
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What Happened after Financial Crises?
Sometimes bad thingsand
Sometimes good things
Numbers are trend corrected so flat line is growing at trend
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Experiences Very Different
GDP per Capita Detrended at 2% 1992 = 100
60
80
100
120
140
1990 1994 1998 2002 2006
Source: GGDC (PPP-EKS)Japan
Finland
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GDP per Capita Detrended at 2% 1980 = 100
60
80
100
120
140
1980 1984 1988 1992 1996 2000 2004
Chile
Mexico
Source: GGDC (GK-PPP)
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Cost of Current Crisis
• Huge bailout of lenders to financial intermediaries by taxpayers
• This means higher tax rates in future and depresses the economy now
• The so‐called stimulus plan is a depressant plan
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Evidence that High Marginal Tax Rates Depress an Economy
• This uses the simple methodology developed in my American Economic Association 2002 Ely Lecture
• Factors other than the marginal tax rate matter
• Also errors in measuring hours worked
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Predicted vs. Actual Weekly Hours
GermanyFranceItaly
Canada
U.K.
Japan
U.S.Spain
IrelandIcelandNew Zeland
Australia
Denmark
Portugal Romania
16.0
18.0
20.0
22.0
24.0
26.0
28.0
30.0
16.0 18.0 20.0 22.0 24.0 26.0 28.0 30.0
actual
predicted
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Effective Measures Against theDepression in U.S. Economy
• Cut marginal tax rates
• Become more open
• Follow pro‐productivity policies
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Openness and Spain’s GDP Per Capita Relative to U.S.
Moderately Integrated Before 1930 42%
Little Integrated 1940‐54 22%
Moderately Integrated 1965 36%
Becomes EU Member 1981 49%
Highly Integrated 2007 61%
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Government Spending Doesn’t Stimulate the Economy
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Summers’ Misguided Advice to Japan
• Repeatedly said to spend and stimulate their economy in 1990s and Japan did
• What happened? Japan lost a decade of growth
• Geithner, who is not an economist, is now advising China to spend in order to stimulate its economy
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Why Japan’s Lost a Decade of Growth?
• Some blamed China
• Others blamed the Bank of Japan
• Still others blamed fiscal policy
– Said Japan needed even bigger deficits
• Hayashi and Prescott in “Japan’s Lost Decade of Growth” find the problem was
lack of productivity growth!
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Why Low Productivity Growth?
• Hayashi and I conjectured: banks subsidizing inefficiencies– Loans were being made to pay interest on
existing loans– Banks’ liabilities exceeded assets
• Subsidizing inefficient businesses deters productivity growth
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Japan’s Reaction
• Cabinet Research Office invited me to talk in 2002
• Signaled Prime Minister Koizumi was buying into the productivity story
• Takenaka, new head of Financial Services, instituted banking reforms
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Banking Reforms
• Wrote off bad loans
• Refinanced insolvent banks
• Required honest accounting when meeting
capital requirements
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What Happened After Reforms
• Productivity growth rebounded
– No helicopter drops of money
– No big increases in spending
– No Chinese collapse
• Reason for rebound
– Making the banking system sound again
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Detrended GDP per Capita
60
70
80
90
100
110
1991 1993 1995 1997 1999 2001 2003 2005
Japan
US
EU - 15
Source: GGDC
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An Efficient Crisis‐Free Financial System
• Friedman argues for 100% reserve banking with interest on reserves
• Justification is stability
• I argue for Friedman’s system for the commercial banking system
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Good Financial Regulation
• Friedman argues for 100% reserve banking
• Justification is stability
• I argue for 100% reserve commercial banking system (with interest on reserves)
• AND a ban on financial intermediation, which rules out Bear Stearns and Lehman Brothers
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Regulation Depresses Productivity
• Actions are often taken for political reasons
• Recent financial crisis and earlier S&L crisis due to policies designed to increase home ownership
• Fannie Mae and Freddie Mac, two government‐sponsored enterprises, began holding subprime mortgages because politicians forced them to
• Congress passed laws that effectively required banks to make subprime mortgage loans when enforced
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Financial Intermediation Serves No Purpose
• Financial intermediation is when a limited liability business borrows from one group and lends to another, and is highly leveraged
• It is just gambling on a grand scale
• When financial intermediaries get big, the taxpayers bail them out when they fail
• As a taxpayer, I don’t like bailing out Goldman Sachs, AIG, and Deutsche Bank
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How Are Investments Financed?
• Currently 80 percent financed by equity and mutual lending
• Other 20 percent financed by bank lending
• The part currently financed by bank lending would have to be financed other ways
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What Other Ways?
• Use more equity
• Use more mutual lending– Mutual insurance companies– Venture capital group– REITS– Mutual pension funds– Hedge funds that do not borrow
• With this reform, all commercial bank lending to government
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Don’t Increase Tax Rates
• European hours per working‐age person 70% of other advanced industrial countries
• Why? Their marginal effective tax rate is 60% versus 40% elsewhere
• In early 1970s tax rate was 40% and they worked the same amount
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• European hours per working‐age person 70% of other advanced industrial countries
• Why? Their marginal effective tax rate is 60% versus 40% elsewhere
• In early 1970s tax rate was 40% and they worked the same amount
• Danger: U.S. will increase its tax rate
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Raising Tax Rates Will
• Not increase revenue in the U.S.
• Will decrease revenue in France, Italy, Germany, and Spain
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Welfare
• Because of taxes, the value of time on margin is twice as high as in the market sector as outside market sector
• Nonmarket time is valuable
• Welfare gains lifetime consumption equivalents per year are …
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What Matters Are Real Factors
• Tax RATES – low rates good• Openness – more is better• Productivity – higher is better
• Problem is not lack of borrowing
• Some banks are refusing deposits in the U.S.
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Poor Prospects for U.S.Productivity Growth: Why?
• Recent abandonment of cost‐benefit analysis for evaluation of new regulations
• Government ownership of auto and banks
• Congress and the White House management of businesses
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Are We in for Another Great Depression?
• The current planned policies in U.S. resemble those followed in 1929‐32
– Anti immigration– Anti globalization– Pro tax increase– Pro White House managing the economy– Pro bailout of businesses– Pro cartelization
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I Expect Not
• Things were going well for the U.S. economy until the fourth quarter of 2008 – rapid productivity growth
• Economic knowledge has advanced so much that it will effectively constrain the policymakers
• But, I fear a lost decade of growth for the U.S. because of tax rate increases and low productivity growth