CASS-CAPCO Conference on Risk The crisis in the US and its causes Patrick Minford April 2012
The US economy- what caused the crisis? • CRITICISM of macro: a) no banking element b) no mechanism for crisis- marked by permanent ('trend') losses of GDP c) unable to `predict' events. • BUT a) banking models widely in use b) nonstationary shocks capable of producing crisis c) the models right that `crisis' cannot be predicted- noone predicted it except for `doomsayers‘ •
NEVERTHELESS models actually being used did not contain banking and only had stationary shocks (no possible crisis)
• HERE -- include banking model in a widely-used macro model of the US -- test it against US data and find estimated parameters for which it fits -- include nonstationary shocks -- model gives a coherent account of banking crises and of this crisis in particular.
The model and its behaviour • Model is reestimated to fit US data as closely as it can and then tested to see whether it does fit. It fits quite well. • Then we use this model in ‘reverse engineering’ to see what ‘shocks’ (i.e. the unexplained parts) the model implies caused the crisis. • We provide an interpretation of the shocks and see how important each was in causing the crisis.
Effects of a rise in interest rates Interest Rate
Investment
Tobin's Q 0
-0.02 -0.04 -0.06 -0.08 -0.1 -0.12
-0.3
0.1
-0.2 -0.4
0.05
-0.4 0
-0.5 2 4 6 8 101214
2 4 6 8 101214
Inflation
2 4 6 8 101214
Wage -0.05
-0.005
-0.015
-0.06
-0.06
-0.08
-0.08
-0.12
-0.1
-0.2
-0.02
-0.25 2 4 6 8 101214
Hours
-0.14 2 4 6 8 101214
2 4 6 8 101214
Premium
Net Worth
0.02
-0.02
-0.4
0.015
-0.04
-0.6 0.01
-0.06
-0.8 2 4 6 8 101214
Output -0.04
-0.04
-0.15
2 4 6 8 101214
Consumption
-0.1
-0.01
Capital
2 4 6 8 101214
2 4 6 8 101214
2 4 6 8 101214
Effects of a rise in productivity Interest Rate
Investment
Tobin's Q
Capital 0.15
-0.01 -0.02
0.5
0.08
0.4
0.06
-0.03 -0.04
0.3
-0.05
0.2
0.1
0.04 0.05
0.02 0
-0.06 2 4 6 8 10 12 14
Inflation
2 4 6 8 10 12 14
Wage 0.6
-0.04
2 4 6 8 10 12 14
Consumption
2 4 6 8 10 12 14
Output 0.7
0.8
0.6 0.5
-0.045 -0.05
0.6
0.5
0.4
-0.055
0.4
0.4
0.3
0.3
-0.06 -0.065
0.2
0.2 2 4 6 8 10 12 14
Hours -0.25
2 4 6 8 10 12 14 -3 Premium x 10
-0.35 -0.4 2 4 6 8 10 12 14
2 4 6 8 10 12 14
Net Worth 0.16
4 2 0 -2 -4 -6
-0.3
0.2
0.14 0.12 0.1 0.08 2 4 6 8 10 12 14
2 4 6 8 10 12 14
2 4 6 8 10 12 14
The crisis shocks implied by the model Government Spending Preferences 0.4
0
0.2 -0.2 08
10
Productivity 4 2 0 06
08
-1 06
08
10
Price Mark-up 0.4 0.2 0 -0.2 -0.4 -0.6 10 06
Premium 3 2 1 0 -1 06
-1
-0.5
0 06
Investment 0
08
10
06
0.5
20
0
10
08
10
06
08
08
10
Labour Supply
-0.5
Net Worth
10
08
Wage Mark-up
2 0 -2 -4 -6 08
-2 06
Taylor Rule 0.8 0.6 0.4 0.2 0 -0.2 -0.4 10 06
10
0 06
08
10
Shocks during the crisis • Taylor Rule=zero bound • productivity continued to grow apart from the heart of crisis. • Wage ‘push’ possible reasons: oil/commodity prices’ effect on real wages resisted? Obama (union power and Obamacare)? LIFO firing causing topheavy wages? • External premium: subprime loans unravelling. Government pressure to build up subprime; Lehman collapse sucks government into a fiscal bail-out. Hence government action both in building and ultimately defusing subprime?
2011
2009
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
US real house prices, 1975-2011
140
130
120
110
100
90
80
Government Intervention in US housing market Political and Legislative Targets 1) 1996 HUD target for F and F: 42% of mortgages to go to borrowers with income below area median (50% 2000; 52% 2005). 2) 1996 HUD target for ‘special affordable’ (borrowers with less than 60% of area median) was 12% (20% 2000; 22% 2005). 3) Also Community and Reinvestment Act of 1977 (Carter) strengthened in 1995 for ordinary banks. F and F securitised $394bn of CRA loans 2000-2002. 4) Taxpayer Relief Act increased CGT exclusion band on houses Source: Nunes (2009)
Government Intervention in US housing market Effects on Home Ownership 1) 1994-2006, US home ownership rate up 9.4% (to 70% of population). Hispanics up by 20.2%; Asians 17.2%; African Americans 14%; non-Hispanic Whites 8.2%. 2) Hispanic population 44% Pacific; 30% South; Asian population 49% Pacific. African American 45% South. 3) Prices in these two regions both take off from 1992 but differentially due to extra supply response in South (less zoning tightness). Source: Nunes (2009)
Shocks effect on output 2006.1 2006.2 2006.3 2006.4 2007.1 2007.2 2007.3 2007.4 2008.1 2008.2 2008.3 2008.4 2009.1 2009.2 8 6 4 2 0 -2
Productivity -4 -6 -8 -10 -12
Preferences Investment Taylor Rule Price Mark-up Labour Supply Premium
Predicted Actual Predicted Actual (no Financial Accelerator) Predicted Actual (ex. Financial Accelerator Shocks)
Shocks effect on Interest Rates 2006.1 2006.2 2006.3 2006.4 2007.1 2007.2 2007.3 2007.4 2008.1 2008.2 2008.3 2008.4 2009.1 2009.2 2.5
1.5
0.5
-0.5
Productivity Preferences -1.5
Investment Taylor Rule
-2.5
Price Mark-up
Predicted Actual Predicted Actual (no Financial Accelerator)
Labour Supply Premium -3.5
Predicted Actual (ex. Financial Accelerator Shocks)
Shocks effect on Inflation 2006.1 2006.2 2006.3 2006.4 2007.1 2007.2 2007.3 2007.4 2008.1 2008.2 2008.3 2008.4 2009.1 2009.2 2 1.5 1 0.5 0 -0.5
Productivity Preferences
-1 -1.5
Investment Taylor Rule Price Mark-up
-2
Predicted Actual (no Financial Accelerator)
Labour Supply Premium
-2.5
Predicted Actual
Predicted Actual (ex. Financial Accelerator Shocks)
Crisis and Financial Crisis •
Crisis a regular capitalist event: charts A for output of selected bootstraps, done for 'normal' shocks (1984-2007). Get one ‘crisis’ on av every 50 years.
•
Financial crisis (sharp rise in premium) accompanies a crisis roughly half the time- charts A and B for the premium.
•
Extreme financial shocks not necessary to generate financial crisis- shocks used contain no Crisis Period shocks.
•
Extreme financial shocks not sufficient on their own to generate crisescharts C of histories with financial shocks only 1984-2009 (including extreme values in crisis). Just recessions and financial distress.
Crisis A: histories without financial crisis Output #11
Output #38
Output #42
150
150
150
140
140
140
130
130
130
120
120
120
110
110
110
100
100
100
0
50
100
0
Premium #11
50
100
0
Premium #38 2
2
1
1
1
0
0
0
0
50
100
-1
0
50
100
Premium #42
2
-1
50
100
-1
0
50
100
Crisis B: histories with financial crisis Output #12
Output #45
Output #54
150
150
150
140
140
140
130
130
130
120
120
120
110
110
110
100
100
100
0
50
100
0
Premium #12
50
100
0
Premium #45 2
2
1
1
1
0
0
0
0
50
100
-1
0
50
100
Premium #54
2
-1
50
100
-1
0
50
100
Histories C: financial shocks only (including crisis shocks) Output #15
Output #20
Output #53
150
150
150
140
140
140
130
130
130
120
120
120
110
110
110
100
100
100
0
50
100
0
Premium #15
50
100
0
Premium #20 2
2
1
1
1
0
0
0
0
50
100
-1
0
50
100
Premium #53
2
-1
50
100
-1
0
50
100
Conclusions about US crisis • Typical crisis caused mainly by ‘traditional’ shocks. The banking shock adds another layer. • The banking shock in this crisis had heavy government intervention in it, both in causing and in defusing it. • Regulation of banking unlikely therefore to prevent crises or banking crises that result. • Regulation of government more effective! But- quis custodiet ipsos custodes? Cf South Sea Bubble and role of UK government.
Policy Conclusions • Dodd-Frank etc unlikely to prevent future crises but will damage banking function. • Zero Bound not a big element. • Fiscal policy shows up via bail-out (taxpayer credit provision) but not otherwise. QE effect also be in end-2008.