Why Is the Recovery from the Financial Crisis So Sluggish? Robert E. Hall Hoover Institution and Department of Economics Stanford University Keynote Address Agricultural and Applied Economics Association Pittsburgh July 24, 2011 1
U.S. Employment Rate for Workers Aged 25 through 54 98 97 96 95 Normal 94 93 92 91 90 89 88 Slump Slump Slump Slump 87 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2
Payroll employment relative to lowest value in the cycle 1.12 1.10 1980 to 1985 Ra atio to lowest value 1.08 1.06 1.04 1.02 100 1.00 0.98 0.96 Current 0.94 24 18 12 6 0 6 12 18 24 30 36 Months from lowest value 3
The basic story, phase I Real-estate binge in the 2000s Buildup of housing and consumer durables Buildup of mortgage, car, and credit-card debt Financial institutions thinly capitalized 4
The basic story, phase II Real-estate prices began to fall in 2007 and have fallen ever since Financial institutions failed because of declining asset values; others severely stressed Credit to households dramatically tightened Homebuilding and consumer spending declined sharply and remains low today 5
Ratios of capital and durables to GDP 1.8 1.6 1.4 Housing and consumer durables 1.2 1.0 0.8 Business capital 0.6 0.4 0.2 0.0 1990 1995 2000 2005 6
Burden of Debt Service 10 Percent of total consumption 5 0 5 10 15 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 7
Spread, in Percentage Points, between Business Loan Rates and Banks Borrowing Rate 3.5 3.0, percentage points Spread 2.5 2.0 1.5 1.0 0.5 0.0 2000 2002 2004 2006 2008 2010 8
Spread, in Percentage Points, between Credit-Card Rates and Banks Borrowing Rate 16 14 Spread, percentage points 12 10 8 6 4 2 0 2000 2002 2004 2006 2008 2010 9
Spread, in Percentage Points, between Mortgage Rates and 10-year Treasurys 3.5 3.0 Spread d, percentage points 2.5 2.0 1.5 1.0 0.5 0.0 2000 2002 2004 2006 2008 2010 10
Indexes of Lending Standards Inferred from the FRB Senior Loan Officer Survey 6 5 4 3 2 Mortgages 1 0 Credit cards 1 Business 2 loans 3 4 2003 2005 2007 2009 11
Index of Google Search Queries for the Term withdrawal penalty 80 70 60 50 40 30 20 10 0 2004 2005 2006 2007 2008 2009 2010 2011 12
Index of Google Search Queries for the Term beer 120 100 80 60 40 20 0 2004 2005 2006 2006 2007 2008 2009 2010 13
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 14
Annual Percent Changes in Output and Prices, 2007 Q4 to 2009 Q4 10 5 Annua l percent change in price 0 55 10 IR IS IE MG MS CS XS SL CD CN XG FN FD 15 20 20 15 10 5 0 5 10 Annual percent change in output 15
Real rate of interest The real rate is the nominal rate minus the rate of inflation. Thus, if the nominal rate zero, the real rate is minus the rate of inflation. If the rate of inflation is exogenous, the real rate is pinned at minus the rate of inflation. 16
The problem 12 Normal demand function Supply function t rate Interest 8 4 0 Normal employment and normal interest rate 44 88 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 Employment 17
The problem 12 Normal demand function Supply function t rate Interest 8 4 0 Crisis demand function Crisis Normal employment and normal interest rate Normal employment and 44 low crisis ii interest rate 88 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 Employment 18
The problem 12 Normal demand function Supply function 8 Crisis 4 Crisis demand function 0 2.5 4 5 Normal employment and low crisis interest rate t rate Interest Normal employment and normal interest rate 88 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 Employment 19
The interest rate fails to do its job 12 Supply function 8 Crisis demand function t rate Interest 4 0 Interest rate pinned at zero Excess supply 44 88 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 Employment 20
A Long Period with the Nominal Short Rate Pinned at Zero 4.5 4.0 3.5 Actual CBO forecast per year, percent Rate, 3.0 2.5 2.0 1.5 10 1.0 0.5 0.0 2008 2009 2010 2011 2012 2013 2014 2015 21
Monetary policy Normal: Fed can stimulate by issuing more reserves, which causes banks to expand lending and lower interest rates Since October 2008: Fed has driven the safe nominal short rate to zero but pays a bit of interest on reserves, so banks just keep added reserves and the Fed cannot expand lending and push the interest rate below zero The Fed has some limited ability to lower longer-maturity interest rates by issuing reserves and using the proceeds to buy longer-maturity bonds quantitative easing (QE) 22
Effect of QE2 on bond interest rates Security Decline in interest rate, basis points 30-year Treasury bond 21 10-year Treasury note 30 5-year Treasury note 20 1-year Treasury bill 1 Long investment-grade coporate 19 Intermediate investment-grade corporate 16 Long junk corporate 13 Intermediate junk corporate -17 A basis point is 1/100 of a percentage point 23
Effect of QE2 on expected inflation Inflation swap, years into future Increase in expected future inflation, basis points 30 4 10 4 5 4 1 5 A basis point is 1/100 of a percentage point 24
The Fed s Exit Strategy and the Likelihood of Inflation The Fed has bought more than $2 trillion in assets since the crisis. Contrary to what you read in the financial press, this was not funded by printing money, but rather by borrowing from banks and paying interest on the loans (reserves). When good times finally return, the Fed can use a combination of assets sales to retire reserves and raising the interest rate it pays on reserves both would raise interest rates. Because the Fed is adaptive it looks at inflation and adjusts to offset it there should be no concern about inflation resulting from its huge asset holdings. 25
Inflation outlook Professional forecasters, 10 year: 2.2 percent Consumer expectations, 5 to 10 year: 3.0 percent Treasury inflation-protected breakeven, 5 year: 2.9 percent The inflation hawks have failed to convince the professionals, consumers, or investors... 26
Fiscal policy: Government purchases 80 Beginning of 60 recession 40 Stimulus bill passed Federal Billions of 20 007 dolla ars 20 0 20 40 60 Sum of Fd Federal, lstate, t 80 100 State and Local 27
Fiscal policy: Transfers Billions of 2007 dollars 300 250 200 150 100 Beginning of recession Stimulus bill passed Extra Government Benefits to Individuals 50 0 2007 IV 2008 IV 2009 IV 28
Effects of fiscal policy Purchases Transfers Total Average federal stimulus, 2009Q2-2010Q1 58 220 Multiplier 2 0.8 Effect 115 176 291 GDP 14,338 Percent of GDP 0.8 1.2 2.0 Average GDP shortfall 8.2 Counterfactural GDP shortfall 10.2 29
Exotic fiscal policy A gradual switch to a consumption tax that is added to product prices rather than subtracted from factor incomes would make current consumption cheaper in nominal terms and eliminate the zero bound. 30
Explaining the excruciatingly slow recovery Households are still constrained by debt incurred during the boom and by credit tightening from the financial crisis. The Fed has done almost all that it can another QE would have close to zero benefit. No chance of conventional fiscal expansion; rather, possible cutbacks motivated by excessive federal debt Even less chance of exotic, revenue-neutral expansion 31
For the future... The main lesson is to avoid the regulatory lapses that caused the accumulation of housing, its associated debt load, and resulting frictions. Dodd-Frank has given the federal government a lot of new tools to improve financial oversight, but it remains to see if they will be used effectively. 32
Material on rising structural unemployment if time permits 33
Total Factor Productivity 120 115 110 105 100 95 90 1999 2001 2003 2005 2007 2009 34
Ratio of UI Benefits to Median Earnings 0.25 0.20 0.15 o Ratio 0.10 005 0.05 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 35
Detrended Index of the Labor Force 1.04 1.03 1.02 1.01 1.00 0.99 098 0.98 0.97 0.96 0.95 0.94 1980 1984 1988 1992 1996 2000 2004 2008 36
Components of Decomposition of Movements of the Labor Force 0.60 050 0.50 Trend 0.40 0.30 0.20 Current employment Lagged employment 0.10 0.00 Random component 0.10 1980 1984 1988 1992 1996 2000 2004 2008 37
Total of Components of Movements of the Labor Force, except Random Component 1.04 1.03 1.02 1.01 1.00 0.99 0.98 0.97 0.96 Labor force index Value projected from employment 0.95 Estimation period through December 2007 0.94 1980 1984 1988 1992 1996 2000 2004 2008 38
Number of Job Openings nds Thousan 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 39
Efficiency of Matching Job-Seekers to Jobs 1.2 1.0 0.8 0.6 0.4 0.2 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 40
The Beveridge Curve 0.040 labor for rce gs per me ember of Job opening 0.035 0.030 0.025025 0.020 0.015 December 2000 through July 2009 August 2009 through August 2010 0.010 0.03 0.05 0.07 0.09 0.11 Unemployment rate 41
Counterfactual Beveridge Curve with Normal Behavior of Matching Efficiency ce labor forc mber of l 0.035 0.030 0.025 December 2000 through July 2009 August 2009 through August 2010 s per me opening 0.020 0.015 Job 0.010 0.03 0.05 0.07 0.09 0.11 Unemployment rate 42
Two Measures of Numbers of New Hires per Quarter 18,000 16,000 JOLTS data 14,000 12,000 10,000 BED data 8,000 6,000 4,000 2,000 0 1992 1994 1996 1998 2000 2002 2004 2006 2008 43
Numbers of Workers Hired and Numbers of Quits, JOLTS 7,000 6,000 Hires Thou usands of workers 5,000 4,000 3,000 2,000 Quits 1,000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 44
Ratio of JOLTS Hiring Rate and BED Job-Creation Rate together with Matching Efficiency 2.5 JOLTS separations/bed separations 2.0 1.5 1.0 Matching efficiency 05 0.5 0.0 2001 2003 2005 2007 2009 45
Fraction of Unemployed Who Quit Previous Jobs 0.20 0.18 0.16 0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 46
Measuring Mismatch in the U.S. Labor Market Ayşegül Şahin, Federal Reserve Bank of New York Joseph Song, Federal Reserve Bank of New York Giorgio Topa, Federal Reserve Bank of New York and IZA Giovanni L. Violante, New York University, CEPR and NBER 47
Unemployment without mismatch 0.11 0.1 U.S. Data Counterfactual M h Unemployment Rate 0.09 0.08 0.07 0.06 Unemployment Rate 0.05 0.04 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Date 28 0.11 48