The MacroeconomyBubbles and Bounceback, the US and Japan

Presentation made at Kendal of Lexington

Michael SmitkaProfessor of Economics

Washington and Lee UniversityAugust 25, 2009

Business cycles

• The Federal Reserve deliberately caused previous post-WWII recessions to dampen inflation– Hence when the Fed eased off on its hikes of interest rates,

the economy “V-ed” back• I believe that a “bubble” recession is different– Excess capacity combined with lower asset values but high

debt are a potent combination– Rapid adjustment of asset prices in the US is bringing us

quickly to a bottom– But recovery will take years, not months

Today...

• I’ll look at the post-bubble experience of Japan• Then I’ll provide a brief overview of recent

data for the US– And at comparable “bubble” data for the US

Japan’s Experience

• A huge bubble during 1987-1991• Very easy monetary policy, huge deficits for

over a decade– As a Japan specialist, I teach a whole course on

this, so dare not start into details!• So how has Japan fared?– See graphs of before & after...

Japanese Urban Real Estate Pricesvs Consumer Price Index Inflation

CPI (inflation)

Commercial Real Estate—6 largest cities—

Japanese Urban Real Estate Pricesvs Consumer Price Index Inflation

CPI (inflation)

Commercial Real Estate—6 largest cities—

18 years!

1980.01

1980.09

1981.05

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2009.054,000

6,0008,00010,00012,00014,00016,00018,00020,00022,00024,00026,00028,00030,00032,00034,00036,00038,00040,000

Nikkei Chart, 1980-dateHow far will corporate profits fall, and priced in already?

First passed 9,000 in

July 1983

Just over 9,000 inMay 2009

Peak of 38,915 inDecember 1989

1980.01

1980.09

1981.05

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2009.054,000

6,0008,00010,00012,00014,00016,00018,00020,00022,00024,00026,00028,00030,00032,00034,00036,00038,00040,000

Nikkei Chart, 1980-dateHow far will corporate profits fall, and priced in already?

First passed 9,000 in

July 1983

Just over 9,000 inMay 2009

Peak of 38,915 inDecember 1989

Nikkei at 10,500 today

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-8.0%

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Japanese GDP Growth(seasonally adjusted, % per annum over previous year)

Bubble Bursts: Peak 1991

Moving Average

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Japanese GDP Growth(seasonally adjusted, % per annum over previous year)

Bubble Bursts: Peak 1991

Moving Average

Japan now in 4th post-bubble recession

0.9% pa real growth

US GDP

• GDP (gross domestic product) – is a measure that attempts to count (but not

double-count) all economic activity– By dividing the economy into • Personal consumption• Business & residential investment• Government consumption & investment• International trade

• Recently the economy has shrunk, not grown

Growth (or its lack) – next 2 slides

• Investment (red outline) has been dragging the economy down

• Government activity (black outline) has only just started pulling activity up

• Trade is important — unusual for the postwar US economy, but less unusual the past decade

• Note that despite Bush and accompanying demagoguery, the government share of the economy hasn’t shifted much

2007-I 2007-II 2007-III 2007-IV 2008-I 2008-II 2008-III 2008-IV 2009-I 2009-II

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GDP Growth and Contribution Factors

State and local Nondefense National defenseNet exports of goods and services Change in private inventories Equipment and software Residential Construction Business Structures Services Nondurable goods Durable goodsGDP

% p

er a

nnum

Stimulus?!

Red outline = investment componentsBlack outline = government components

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00.5

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Shares of GDP: Government Sectors

Federal

National defense

Nondefense

State and local

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III 1995

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-7-6-5-4-3-2-10123456789

10111213141516171819

Shares of GDP: Trade

Net exports

Exports

Imports

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Business Investment: Structures

Business Investment: Equipment & software

Residential Con-struction

Unemployment – next 6 graphs• In 1933, unemployment was roughly 25%

– Or 11.4 million Americans in a population of 127 million• And two-income households were not the norm

• In July 2009 unemployment was 9.4%– Or 14.4 million Americans in a population of 307 million

• But dual-income households & supplemental income are both more prominent– We don’t (yet?) see 1930s-style homelessness

• In normal times voluntary quits and new entry means 4.4 million Americans are counted as unemployed– the recession has thus added “only” 10 million

• Nevertheless, we are looking at an economic disaster– that affects as many people as the Great Depression

1948 1950 1953 1956 1959 1962 1965 1967 1970 1973 1976 1979 1982 1984 1987 1990 1993 1996 1999 2001 2004 20070

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

US Unemployment, Total Numbers by Duration (1,000s of people)

U Less than 5 weeksU 5 to 14 weeksU for 15 Weeks & overU for 27 Weeks & over

8 million

Long-term unemployment is worse than at any time in the past 60 years

19751976197719791980198219831984198619871989199019921993199419961997199920002001200320042006200720090.0%

1.0%

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6.0%

Unemployment by Duration as % of Labor Force

U < 5 wksU 5-14 wksU 15-26 wksU 27+ wks

1978197919811982198419851987198919901992199319951997199820002001200320042006200820090.0%

1.0%

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Labor Market Entry & Exit

Headline U Job losersTotal Frictional New entrants Reentrants Quits/Job Leavers

Job losses (red) dominate the rise in unemployment,but people returning to the job market (blue) – such

as spouses seeking work – also matter

2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009 20100.0%

1.0%

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Underemployment and Unemployment— total pain measure —

Involuntary short hoursMarginally attachedDiscouraged workersHeadline UnemploymentTotal Pain Measure

It’s not just “headline” unemployment, but also peoplewho have had their hours cut or are discouraged aboutfinding a job and are no long counted as unemployed

Bubble

• Real estate prices zoomed– But only in some metropolitan areas– Particularly those where “supply” is constrained by

geography and/or local policy• And lots of debt incurred in the process– But mainly by people with lower credit scores– Over the short run, those with low incomes (or poor

track records of self-restraint) got access to credit• But the old rules-of-thumb were appropriate: they are the

ones going into default

Jan-87

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Jan-09

4047.5

5562.5

7077.5

8592.5100

107.5115

122.5130

137.5145

152.5160

167.5175

182.5190

197.5205

212.5220

227.5235

242.5250

257.5265

272.5280

Case-Shiller Housing Price Index

AZ-PhoenixCA-Los AngelesFL-MiamiNV-Las VegasReal GDPNominal GDPCPI

116

160

145

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405060708090

100110120130140150160170180190200210220230240250260270280

Bubble vs Stable Housing Markets

CA-Los AngelesCO-DenverFL-MiamiGA-AtlantaIL-ChicagoMI-DetroitNC-CharlotteOH-ClevelandTX-DallasNominal GDP

　 　 　 　 　 　　 City % Average Amount Total Amount 　　 Underwater Underwater Underwater 　　 　 　 Per House $ millions 　　 Atlanta 45 $18,016 $984 　　 Boston 21 $17,156 $202 　　 Chicago 35 $18,201 $965 　　 Cleveland 32 $9,865 $114 　　 Denver 33 $12,607 $267 　　 Las Vegas 89 $83,654 $7,872 　　 Los Angeles 52 $80,484 $13,594 　　 Miami 69 $68,357 $10,418 　　 Minneapolis 61 $32,839 $1,156 　　 New York 13 $22,119 $823 　　 Phoenix 80 $73,314 $9,025 　　 Portland 24 $18,676 $191 　　 San Diego 61 $84,371 $4,497 　　 San Francisco 39 $65,986 $2,831 　　 Seattle 21 $17,125 $236 　　 Tampa 60 $37,110 $1,889 　　 Washington, D.C. 47 $52,113 $3,398 　　 Seventeen-area composite 47 $58,496 $58,461 　　 　 Dec 2008 data? 　 　 　 　

Half!

Prices Have Adjusted Quickly

• “This year, in 14 ZIP codes in Southern California, including Moreno Valley’s, median home prices have fallen below 1989 levels, making places like Beth Court affordable for the first time to many new homeowners.”

– Jennifer Steinhauer. “Beth Court: A Cul-de-Sac of Lost Dreams, and New Ones.” The New York Times, August 23, 2009.

– But recovery requires new construction, not just stable prices – we built a lot of new houses the since 2002

Japan comparison: Conclusion

• Are we like Japan looking at a decade-plus of 1% growth?– NO, thankfully

• Why?– Japan’s labor force is shrinking• Averaged across the business cycle, Japan’s economic

growth will therefore inevitably be low• But a low average means even a mild downturn results

in negative growth / a recession

Much of the world will look like Japan

• The children of Japan’s baby boomers aren’t having children– There are fewer toddlers (age 0-4)• than doddlers (age 70-74)

• Many countries have the same demographics– Including China, Korea, Taiwan, Spain and Italy• All are at or soon will hit the point where their native-

born population will shrink– While immigration may help Spain, it’s hard to imagine 100+

million people moving to China in 2030-2050...

50045040035030025020015010050050100150200250300350400450500

０ 〜 4

５ 〜 ９10 〜 14

15 〜 19

20 〜 24

25 〜 29

30 〜 34

35 〜 39

40 〜 44

45 〜 49

50 〜 54

55 〜 59

60 〜 64

65 〜 69

70 〜 74

75 〜 79

80 〜 84

85 〜

０ 〜 4

５ 〜 ９10 〜 14

15 〜 19

20 〜 24

25 〜 29

30 〜 34

35 〜 39

40 〜 44

45 〜 49

50 〜 54

55 〜 59

60 〜 64

65 〜 69

70 〜 74

75 〜 79

80 〜 84

85 〜

Japan's Population Age Structure

Female Male

1,000 people

Born 1970-74

Born 1945-49

Born 1995-99