Understanding the Financial Crisis
Presentation to
Students & Friends of Rensselaer Hartford
Hartford, CT
James Stodder, (Ph.D., Economics, Yale 1990)
Lally School of Management & Technology
Rensselaer Polytechnic Institute at Hartford
Hartford, Connecticut, USA
Thursday, April 9, 2020 1

1.
2.
3.
4.
Keynes on Credit Cycles:
- Why we need Regulation
Where is the Bottom?
Connecticut is “Middle of the Pack”
Government Deficit Spending a.
b.
Needed in the Short-term
But a Big Problem Long-term
Thursday, April 9, 2020 2

(1) Biz & Credit Cycles
J. M. Keynes: 1883-1946
Thursday, April 9, 2020 3

US Macro-Stability:
Better, Room for Improvement
Average U.S. Business Cycle, 1854 to 2006
Contraction Expansion
1854-1919
(16 cycles)
45% 55%
1919-1945
(6 cycles)
34% 66%
1945-2006
(10 cycles)
15% 85%
Thursday, April 9, 2020
0 10 20 30
Months
40 50
Source: http://www.nber.org/cycles.html
60 70
4

Bad News: Bubbles are Endemic
Thursday, April 9, 2020
Arlington Williams, “Price Bubbles” www.indiana.edu/~arlwilli/pdf%20files/bigmkts.pdf
5

V. Smith & A. Williams,
“Experimental Market
Economics,” Scientific
American, Dec. ‘92
6 Thursday, April 9, 2020

Price/(10 Year Avg. Earnings)
1880-2015
Source : http://www.econ.yale.edu/~shiller/data.htm
Thursday, April 9, 2020 7

“A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way, along with his fellows, so that no one can really blame him.”
- J.M. Keynes (1931)
Thursday, April 9, 2020 8

“Paradox of Thrift” Keynes noted:
Consumers cut back on their spending and save more during a recession . This only makes the recession worse .
Similarly for Banks , Loan Loss Reserves
(LLR) are often raised in a recession , just when households and businesses most need credit –ensuring more collapses and worsening the recession .
Thursday, April 9, 2020 9

Insurance => Moral Hazard =>
Necessity of Regulation
Moral Hazard of Insurance:

If you had a car that is less damaged by any given car crash – would that make you drive faster?

If you (and everybody else) drove faster, could this actually wind up making you less safe ?
Thursday, April 9, 2020 10

www.economist.com/finance/displaystory.cfm?story_id=12480887 www.nytimes.com/2008/10/03/business/03sec.html
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Currency & Reserves Up 5x
Thursday, April 9, 2020
March 4, 2015 http://research.stlouisfed.org/fred2/series/BASE
13

Thursday, April 9, 2020 http://research.stlouisfed.org/fred2/series/WRESBAL
Mar. 4, 2015
14

M0 = Currency + Bank Reserves ≈ $3.9t
Thursday, April 9, 2020
Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/BASE
15

M1 ≈ $3.0t = Currency + Bank Deposits
Thursday, April 9, 2020
Mar. 4, 2015 http://research.stlouisfed.org/fred2/series/M1
16

Money Mult . = M1/M0 ≈ 3.0
/
3.9 = 0.77
Thursday, April 9, 2020
Oct. 17, 2012 http://research.stlouisfed.org/fred2/series/MULT
17

If l = % loans, Reserve multiplier is
D = R(1+ l + l 2 +
+ l ∞
= R/(1l )
If M0 = Currency (C) + Reserves (R),
M1= Currency + Deposits , so:
M1 = C + R/(1l ) = M0–R + R/(1l )
M1/M0 = 1+{ -R + R/(1l ) }/M0
Thursday, April 9, 2020
So M1/M0 < 1 => l < 0
18

Limits of Fed Magic
Thursday, April 9, 2020
New Yorker, Oct. 2008
19

Thursday, April 9, 2020
Mar. 4, 2015 http://research.stlouisfed.org/fred2/series/TB3MS
20

Thursday, April 9, 2020
T.I.P.S.
21

M*V ≡ P*Y
Money * Velocity ≡ Price * Output => ln(M) + ln(V) = ln(P) + ln(Y) => i.e.,
%
∆
M + %∆ V = %
∆
P + %
∆
Y over time
Thursday, April 9, 2020 22

9-Apr-20
%∆ GDP [ = % ∆ Money + %∆ Velocity) ] is Pro-Cyclical because of falling Velocity
% ∆M
% ∆ GDP
% ∆ V
23

Keynes’s Liquidity Trap: interest
rate
FISCAL Expansion:
Investment Demand = Savings
FISCAL Expansion:
Money Demand = Supply
Thursday, April 9, 2020
GDP
24

Keynes’s Liquidity Trap:
FISCAL Expansion:
Investment Demand = Savings
MONETARY Expansion:
Money Demand = Supply
Thursday, April 9, 2020
GDP
GDP
25

Keynes’s Liquidity Trap: interest
rate
FISCAL Expansion:
Investment Demand = Savings
FISCAL Expansion:
Money Demand = Supply
Thursday, April 9, 2020
GDP
26

Keynes’s Liquidity Trap: interest
rate
FISCAL Expansion:
Investment Demand = Savings
FISCAL Expansion:
Money Demand = Supply
Thursday, April 9, 2020
GDP
27

Source: IMF World Economic Outlook and IMF Fiscal Monitor, Oct. 2012
Thursday, April 9, 2020 28

Another Illustration: Multiplier > 1
Thursday, April 9, 2020
NY Times, Oct. 23, 2012
29


Okun’s Law, and Very Slow Recovery
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Okun’s Law (1): Unemployment Gap
Thursday, April 9, 2020
Mar. 4, 2015
31

Okun’s Law (2): Output Gap
Thursday, April 9, 2020
Mar. 4, 2015
32

Thursday, April 9, 2020
33

 http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08-
Outlook_Testimony.pdf
Bigger 2009 stimulus needed to fill it:
20% * $14 tr. = $2.8 tr.
Stim*1.5 = $2.8 => Stim = $1.87 tr.
Thursday, April 9, 2020 34

Worst Long-Term Unemployment
Mar. 4, 2015
Thursday, April 9, 2020 http://research.stlouisfed.org/fred2/series/UEMPMEAN 35

Long Unemployment Dip
Thursday, April 9, 2020 http://cr4re.com/charts/charts.html
36






Financial Sector down, but ..
Conventional Banking and Insurance less vulnerable than Investment
Banks, Financial Insurance
Defense industries well insulated
Pharmaceuticals and Biotech have good long-term prospects
House Price Increases near US Avg.
Thursday, April 9, 2020 37

International Housing Prices
Thursday, April 9, 2020 38

Sun Belt, Rust Belt Concentration
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Thursday, April 9, 2020 40

US Price-Rental Ratio
1960-2015
Souce: www.lincolninst.edu/subcenters/land-values/rent-price-ratio.asp
Thursday, April 9, 2020 41

Thursday, April 9, 2020
Source: NY Times, April 20, 2010
42

Long Term Fiscal Gap: Unsustainable http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
Thursday, April 9, 2020 43

Sure as Debt and Taxes http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
Thursday, April 9, 2020 44

Implications of Limited Pass-Through
Linda Goldberg (FRBNY) has shown that
Dollar Devaluation means:
• Improved Earnings on Foreign Assets
• Easier Debt Servicing
• Smaller Trade Deficit
And at the same time,
• Minimal Costs in further Inflation
So - What’s Not to Like?
• FRBNY Governor Frederic Mishkin says
“Devaluation cannot be a policy.” (I think he means an explicit policy.)
Thursday, April 9, 2020 45

Inflation/Devaluation a Powerful Temptation for
Highly Indebted Governments
• Germany after WWI
• Russia after the Revolution
• Soviet Union after the Cold War
• Many Developing Countries after spending, investment binges
(See L. Kotlikoff & S. Burns,
The Coming Generational Storm, 2004)
46 Thursday, April 9, 2020

Implications of Limited Pass-Through
Linda Goldberg (FRBNY) has shown that
Dollar Devaluation means:
• Improved Earnings on Foreign Assets
• Easier Debt Servicing
• Smaller Trade Deficit
And at the same time,
• Minimal Costs in further Inflation
So - What’s Not to Like?
• FRBNY Governor Frederic Mishkin says
“Devaluation cannot be a policy.” (I think he means an explicit policy.)
Thursday, April 9, 2020 47

Inflation/Devaluation Appears a “Painless” Way Out of Debt
Thursday, April 9, 2020 48





Recession is long and deep : housing slump, interbank lending, financial markets likely to
“overshoot” on low side.
CT, NY are “ middle of the pack ” for housing prices and employment stability.
Greatly expanded federal spending is needed in the short-term .
Long-term , however, US government debt is unsustainable .
Thursday, April 9, 2020 49