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Economics 435The Financial System
Lecture 19/2/2014
Instructor: Prof. Menzie ChinnUW Madison
Fall 2014
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Administrative Issues
• Course website: http://www.ssc.wisc.edu/~mchinn/web435_f14.html
• OH: TuTh 1-2, 7418 Soc Sci• Textbook: Chinn/Frieden, Lost Decades• Cecchetti/Schoenholtz, or Mishkin• Additional Readings: from web,
Econbrowser, CBO• NYT, FT, WSJ, Economist
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Administrative Issues• Grading: 10% PS, 50% 2×MT, 40% paper• Dates:
- MT on 10/14, 11/20- Paper due on Fri, 12/11
• Make-ups: None. Points are re-allocated if you have a legitimate excuse. No late assignments accepted (must be handed in during lecture)
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Outline
• The Financial Crisis of 2008-09• The Great Recession of 2007-09 and the
slow recovery• Extraordinary monetary policies• Europe
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Risk and Crisis
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Motivating Questions• Why did the financial crisis occur?• Was it all financial?• How did financial problems get transmitted
to the real side?• What are the similarities and differences
between the past episodes (e.g., the 1929 crash) and this crisis.
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Government and national borrowing
Note: Fed. Budget balance is net lending. Source: BEA
-.12
-.10
-.08
-.06
-.04
-.02
.00
.02
70 75 80 85 90 95 00 05 10
Budget balanceto GDP ratio
Current accountto GDP ratio
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Real interest rates
Source: Federal Reserve Board, Philadelphia Fed SPF
-4
0
4
8
12
16
70 75 80 85 90 95 00 05 10
Ten year Treasuryyields, %
Ten year TIPSyields, %
Ten year Treasuryyields minus exp'd infl., %
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The “Disappearance” of Risk
Source: IMF, WEO update, 11/6/08
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Household debt (I)
Source: BIS, Annual Report (2011)
50
60
70
80
90
100
110
120
2000 2001 2002 2003 2004 2005 2006 2007 2008
US
GreatBritain
Ireland
Spain
Household debtto GDP (BIS)
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Household debt (II)
Source: BIS, Annual Report (2011)
60
70
80
90
100
110
2000 2001 2002 2003 2004 2005 2006 2007 2008
US
Germany
Japan
Household debtto GDP (BIS)
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Housing boom (I)
0.8
1.0
1.2
1.4
1.6
1.8
2.0
00 01 02 03 04 05 06 07 08 09 10 11
US
GreatBritain
Ireland
Spain
Real residentialprices (BIS)
Note: Rescaled to 2001Q4=1. Source: BIS, Annual Report (2011)
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Housing boom (II)
0.7
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
00 01 02 03 04 05 06 07 08 09 10 11
US
Germany
Japan
Real residentialprices (BIS)
Note: Rescaled to 2001Q4=1. Source: BIS, Annual Report (2011)
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Leverage (as of 2007)
0
5
10
15
20
25
30
Comm. Savings Credit Brokers/ GSEsbanks banks unions hedge funds
Average
Asse
ts a
s a
Mul
tiple
of C
apita
l
Source: Greenlaw, Hatzius, Kashyap, and Shin (2008)
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Boom and Bust in the Shadow Financial System
Source: Federal Reserve Board
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Leading to Recession/Depression
Source: BEA, 2012Q3 3rd release, CBO (Aug. 2012), WSJ
14,000
14,500
15,000
15,500
16,000
16,500
17,000
17,500
18,000
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
GDP,bn Ch.09$SAAR
CBO potentialGDP (Feb 2014)
CBO potentialGDP (Aug 2014)
Actual
CBO f'cast
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Consumption and Wealth
Source: BEA, 2014Q2 2nd release, Fed Flow of Funds
8.6
8.7
8.8
8.9
9.0
9.1
9.2
9.3
9.4
10.0
10.2
10.4
10.6
10.8
11.0
11.2
11.4
11.6
90 92 94 96 98 00 02 04 06 08 10 12
Consumption,SAAR[left scale]
Householdnet worth[right scale]
In logs,in bn. Ch09$
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Investment
Source: BEA, 2013Q3 3rd release
9.0
9.1
9.2
9.3
9.4
9.5
9.6
9.7
6.8
7.0
7.2
7.4
7.6
7.8
8.0
8.2
90 92 94 96 98 00 02 04 06 08 10 12
GDP[left scale]
Fixed investment[right scale]
In logs,bn. Ch09$SAAR
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Conventional Monetary Policy
Source: St. Louis Fed FRED system
0
2
4
6
8
10
12
90 92 94 96 98 00 02 04 06 08 10 12 14
Fed fundsThree monthTreasurys
Ten yearTreasurys
BAA
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Quantitative Easing, Operation Twist
http://www.clevelandfed.org/research/data/credit_easing/index.cfm
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The Other Side of the Fed Balance Sheet
http://www.econbrowser.com/archives/2012/08/us_monetary_pol.html
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Policy Uncertainty
Source: Policy Uncertainty, http://www.policyuncertainty.com
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Europe
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ECB Drives Down Sovereign Yields
0
5
10
15
20
25
30
2007 2008 2009 2010 2011 2012 2013
Germany
Ireland
Greece
SpainFrance
Italy
Portugal
Ten yeargov't bondyields, %
OMTformallyannounced
Source: ECB
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The Current Puzzle
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
-.02
.00
.02
.04
.06
.08
.10
.12
.14
.16
70 75 80 85 90 95 00 05 10
Federal debtheld by public,to GDP ratio[left scale]
Ten yearTreasurys[right scale]
TIPS
Ten yearminus exp'dinflation