« February 22: Equilibrium in the Full-Employment Flexible-Price Macro Model | Main | February 25 Lecture Notes: Full-Employment Flexible-Price Model: Equilibrium »

February 25, 2008

Comments

Joe Cummins

Richard Green seems to offer a much more empirical set of arguments than we are studying in class. Most of his arguments about the likely successfulness of the President's/Fed's stimulus package are essentially along the lines of "it worked last time...and this time there is more of it." This kind of argument has some clear advantages to the model based arguments we tend to study in class. For starters, it is based on events that happened (and have been then interpreted) in the world, not so long ago, unlike models which, though based on historical examples, cease to rely upon the real world once set in motion.
On the other hand, I think there are some legitimate concerns with his historical analyses. First, he admits quite openly that this coming recession is not like previous recessions, but never questions whether or not there really is a recession coming or whether this stimulus is right for this recession. Secondly, he admits that attempts to stop a recession before it starts (he refers to this being faster acting stimulus) has not really been tried in the past. To be fair, he admits quite openly that this recession looks different from 2001, but he never really seems to extend that questioning into whether or not the same stimulus will be effective. These problems (of oversimplification and imperfect historical equivalence) are problems faced by all historians.
The models we study allow us to see, without historical aid, the effects of certain policies or potential policies. But these models are just approximations of things already seen in the real world, and then extended, sometimes dubiously. Historical analysis allows a relation to concrete events, but carries with it all of the problems of historical interpretation, perspective bias, political ideology (maybe present in model building too, to be fair) etc. I'll just let anyone interested argue about which is a better method. I think they both have their strengths and limitations. A discussion on what kinds of analysis reveal what kinds of information best would be particularly interesting to me.

j

Valerie Cheung

In the article “Comparing 2008 Economic Trends to 2001”, the author compared the recession in 2001 with the present situation and suggested that the 2001 recession was caused by a “downturn in business investment and output…Throughout that recession, consumer spending and the housing sector held up well.” However, it is not mentioned that it is not the case in today’s economy. The potentially upcoming recession is caused by the declining of consumer spending, and the fear of the drop in housing sector due to the excess of housing constructions. Although it was mentioned in “The Impact of Monetary and Fiscal Stimulus--It Works” that “the government passed a retroactive reduction in the lowest tax bracket that in effect created tax rebates for individual filers of $300, and $600 for couples” to boost consumer spending, it is not definite that they will spend the money in the economy or to help pay off their already-spent credit card balances. However, Bernanke Fed responded earlier to the recession than Greenspan by cutting the fed funds rate. It was also mentioned in the article that the payroll in 2008 was at least higher than in 2001. This might be a trade-off with higher inflation rate. I agree with the previous comment on whether this recession is upcoming or not is still left unanswered. Also, in the flexible-price model that we studied in class, it accounts for the medium run. In the long run, cutting the rates will have mere effect on the economy.

Dena Fehrenbacher

Richard Green states (between the two articles) that the potential 2008 recession will be different from the 2001 recession for three reasons:

1) The Fed has responded much earlier to this one (has already started cutting interest rates) than the recession in 2001.

2)The fiscal stimulus rebate checks are twice as large as they were in the 2001 recession.

3)Housing trends are drastically worse this time around. However, since Residential Construction only accounts for 4.2% of Real GDP, the fiscal stimulus and monetary stimulus should combat this added housing disadvantage.

However, in pointing out these three distinctions of the 2008 recession, and in categorizing them as positive, positive, and mildly negative, Richard Green makes three assumptions that might not hold up in reality.

1)While the Fed has started cutting interest rates, I-sub r (the marginal propensity to invest) might be much lower than in 2001, and thus investment might not respond well to these interest rate cuts.

2)While the fiscal stimulus rebate checks are twice as large this time around, that does not indicate that citizens will spend twice as much on consumption and investment with the checks. They may (and he concedes this point) spend the majority on paying of credit card debt.

3)He claims that, though the Residential Construction market has tanked, it only accounts for 4.2% of Real GDP and shouldn't have a large effect on the recession. However, a loss of even half of that--2.1% of GDP-- may have larger effects than he communicates. "Large" is a relative term. 4.2% may not be as small as he tries to make it sound.

Xueyao Liu

Well, it is certain that there are factors that Richard Green didn’t take into consideration. However, the comparisons that he made are still very legit, especially the comparison between different tax deduction policies. Yes, it is not guaranteed that people today will spend all their tax returns on consumption (very likely, they won’t), but people didn’t spend all their tax return on consumption back in 2001, either. The proportion that people are spending over time is probably a constant. Now, the government increased the base number for that fraction by making the tax return checks bigger. Therefore, the expected increase in consumption should be bigger as well, holding the proportion constant. On top of the fat tax return check, the government reacted very early this time. It seemed that, from Green’s point of view, we have a good chance of avoiding the recession. However, the model in class would suggest that a decrease in tax rate would probably result in a decrease in government spending as well because the government won’t have as much to spend. The total consumption of the entire economy will probably remain unchanged. In Green’s analysis of 2008 and 2001 economics situation, he didn’t take into account government spending at all. Consumer spending seems to be dominating in total consumption. This statement may or may not be true today.

In his articles, I have the most problem with his analysis for employment trend. I don’t think the relatively steady pay roll number indicates that unemployment won’t rise significantly rapidly. This time around, not just the government, but also the investors are much smarter, more educated and more sensitive to the possibility of a recession. It is very likely that institutions overact to their fear. Just last month, many financial institutions like GS and MER made the decisions to fire about 3% - 5% of their labor force due to the loss in the credit market turmoil. It was a fairly quick decision. I believe that their payroll numbers have been steady before things like this happened. Well, the point that I am trying to make is that just because people have a job right now, they are guaranteed to have a job tomorrow. When senior management panic and overreact, there is a good chance that unemployment rate will rise out of nowhere. I don’t think a lot of businessmen are thinking very rationally today because of their smartness and the fear that has caused them. When people behave irrationally, a lot of things can happen. Panic attacks and the possible crazy behaviors of people under these circumstances are things that both models in class and Green did not take into account.

Ying Cindy Wu

Compared to the recession in 2001, Richard Green believes that the current one will cause much less of an impact because of the faster responses to the signals of a downturn. Instead of waiting for the recession to hit as did the Greenspan Fed, the Bernanke Fed cut rates much sooner. In addition, the government tax cuts are also almost twice as large. Based on implications that those policies got us out of the recession last time, this time around, because those actions were taken much sooner and at a much more aggressive pace, it indicates that the recession should not hit as strongly. However, this does not take into account the reasons for the recession and how similar this current one is compared to previous ones. Using historical data as a basis for action is a good plan, but because government policies have such a large impact on the economy, if the recession is not caused by similar factors, the policies may serve to have much more adverse effects, especially because the impacts are not felt until months later, which could even multiply the downturns. Yet, based on the models presented in class, the policies described in Green’s articles all serve to increase consumption. Although not all of the tax cuts will be spent on goods, the proportion saved will eventually (through loans and whatnot) go to investment, which inadvertently goes towards GDP later on as well. So, even though this particular recession shows signs completely different than ones before, the fact that the government is taking steps that has previously combated recessions (and worked) so soon indicates that Green’s conclusion may not be so far fetched.

Hovhannes Harutyunyan

One the main noticeable distinctions between Green’s analyses of the economy and our class model is the inclusion of international trade. Although the inclusion would not counter his forecasts on the effects of lower interest rates, Green neglects to mention the impact of lowered interest rates on foreign saving. As real interest rates decrease because of the Bernanke Fed’s rate cuts, foreign saving will also decrease causing investment spending to decrease. However, the larger increase in domestic spending will be enough to offset the decline caused by foreign saving. Green, nonetheless, does attribute the real interest rate as a powerful, key factor in controlling investment and saving similarly to our textbook. I do appreciate the reliance of his analysis on empirical arguments compared to the mathematical model studied in class, as observed by the first commenter. I feel that the mathematical model’s inability to rely on or make use of empirical data as a significant shortcoming. In the real world, the types and effects of economic policy can be better evaluated through not only the use of a math model but also the studies of previous cycles. With textbook calculations, every different set of parameters entered into the formula each time give a prediction that, although adequate, neglects the significance of data from similar policies enacted in the past; almost as if the economy is unconditionally starting anew every time parameters are plugged into the formula.

But in Green’s analysis, evaluations of the two previous cycles (1991 and 2001) serve as a strong reference for many of his interpretations and forecasts for the current state of the economy. This may not be too smart of an idea either because I feel his comparisons between the 2001 cycle and the 2008 cycle are too dangerously close sometimes. For example, he argues along the lines that since 2008 is not experiencing analogous declines in factory orders, industrial production, and unemployment trends as in 2001, thus we can interpret these as strong indicators of the magnitude of a potentially coming recession. But 2008 is not 2001 and the economy isn’t unilaterally experiencing the same economic difficulties. In 2001, the Fed’s concern was primarily on boosting investment spending whereas in 2008 the Fed is concerned with not only in investment spending but also the rapidly diminishing level of consumption spending and consumer confidence as the fears of recession slowly heighten. This morning BBC released an article reporting that consumer morale has hit a five-year low (http://news.bbc.co.uk/2/hi/business/7265357.stm).

That is why I am little hesitant to share his overly optimistic attitude. Although investment and factory production are at record levels, I feel that declining consumption (2/3s of real GDP) is going to be the biggest obstacle for the Fed in 2008. Ultimately, I think declining consumption will outweigh increasing investment spending, which is usually 15% of real GDP according to our textbook. A lot of the recession fears seem to be perpetuated by the continuous releasing of negative press, which is a point Green addresses in both articles. I feel that the constant wave of recession-themed articles is only going to make consumers and firms expect the possibility of a recession more so. This in itself may cause contractions of economic behavior on both parties that can lead to an economic self-fulfilling prophecy. Also, to bring one counter argument to Green’s article, the lieu of interest rate cuts starting from back in September may not be as good of a thing as he thinks. In fact, it may be the exact opposite. Think about it, if the Fed has been cutting rates since September and it still thinks the economy is headed nowhere, this may mean that economy’s problems are far greater than initially thought. Lastly, our class discussion includes the idea of animal spirits, which Green does not bother mentioning in his analysis and how it can influence investment. If consumer morale is low, then perhaps managerial attitudes may be low for similar reasons as well causing an additional lack of investment.

Tim Wang

As noted previously, Green cites facts and figures from the real world for analysis unlike our purely mathematical models studied in class. Also as aforementioned, the conclusions reached from his analysis more or less agree with the results derived from anaysis of the Full-Employment Flexible-Price Model.

However a discrepancy exists between the treatment of the variable for output (Y) in our model, which is fixed in the medium-run analysis that we are conducting and Green's. GDP is clearly changing quantity in the real world even over short periods of time and in Green's analysis, GDP is utilized as a measure of the "depth" of this and previous recessions. This is also true of employment as labor statistics were cited (ie lay-offs). Our current model assumes there is full-employment. Things like unemployment and market inefficiencies are only considered in the short run. It seems that Green's analysis provides a more comprehensive views of the economy than what we have discuss thus far in cass.

Anela Chan

Dick Green in his two articles of optimism dismisses fear of prolonged recession. In the first article he explains how Federal monetary and fiscal policy worked in the past and how they will work even more successfully this time due to the aggressiveness of the rate cuts and rebate package. In the second article he uses production and unemployment trends to dismiss the fact that a downward trend even exists. I suppose my first problem with his justification is his highly selective manipulation of facts and figures. He pretends that 9-10 months of recession is okay, that payroll drops are dismissible, and that a slump in a sector that accounts for 4.2% of GDP will have little effect on anyone. He also points to just a few trends that are certainly subject to irrational shocks at any time—for instance, unemployment rises may be moderate right now, but they certainly could jump in the coming months—while ignoring others like the falling stock market. Most of all, Green acts as if the current downturn is just like any other recession. While history can certainly teach us valuable policy lessons, we must also pay attention to the specifics of the current situation. A recession caused by a complex financial situation involving a housing bubble and subprime fall-out is not necessarily the same as the one caused by the dot-com bubble burst.

We can use our medium-run model to analyze the components of GDP that may decrease in the next coming months. Government spending seems completely exogenous and net exports should rise (though not necessarily very quickly), so we can look at Consumption and Investment. Green assumes consumption will hold up but has basically no basis for assuming so. If C = Co + Cy(1-t)Y and we ignore changes in Y, we still have the possibility for both the baseline consumption level Co and marginal propensity to consume Cy to fall. Either of these consumption parameters could fall as the housing bubble bursts and people lose large portions of their wealth (a uniquely 2008 phenomenon) or simply as consumers start to fear recession. In fact, contrary to Green’s optimism, I actually decreased my personal consumption spending budget because I know I have to write the University of California another $20,000 next fall and don’t want to sell any of my stocks when they’ve lost value. And then there is investment, which we know as I = Io – Irr. Either investors’ “animal spirits” Io could fall or their marginal propensity to invest. I think there is plenty of evidence that indicates a fall in investor confidence and maybe propensity to invest. Because the current crisis is due largely in part to subprime lending, banks are in more trouble than usual and therefore investment certainly may decrease. Every news day I hear of fear on Wall Street.

So while I am pleased that the government is learning from the past and taking countercyclical action more aggressively than ever before, we must remember that there are many variables at work in the GDP equation. We hope to offset the effects of a recession by changing r and t, but we cannot assume quick recovery when a variety of other parameters affect the equation.

Nick Broten

Green is right to look towards the past for some insight into the current economic environment. His comparison of the response rate to slowdowns in economic growth by the Fed and the government in 2001 and 2008 is illuminating: in the medium run, access to cheap liquidity (courtesy of the Fed's cuts) and a fresh supply of rebate money from the government will circulate through the economy and make sure things don't get too bad. I think most economists agree that these measures will be successful in this quasi-medium-run timeframe of a year and a-half to two years. Stepping back from this medium-run perspective, and focusing on the fundamental causes of the current economic malaise, the picture is less clear. In 2001, the economy was starting to slow down following the expected burst of the tech bubble of the 90s. The current slowdown seems to be driven by two, related, trends: first, over-speculation in the housing market; and second, a great deal of frivolous consumption driven by exaggerated home prices. These two asset bubbles (2001 and 2008) differ greatly in composition: technology is flexible, and can be easily transferred from one unproductive sector of the economy to a productive one. A technology boom produces not only product but intellect and know-how, raising the general effectiveness of the labor force (E). The unraveling of a housing boom produces empty lots and lots of debt, and will not inherently add any efficiency factor to the workforce.
The stock market bubble of the late 1990s made our economy stronger in the long run. It is dubious whether the frivolous consumption and inflated housing market of today will have a similar effect. Green's optimistic analysis is nice to hear, if only for its faith in the effectiveness of our financial and monetary institutions. Unfortunately, consumers might have to reform themselves too.

Kevin Ahn

The first article recalls the periods of recession experienced in 1991 and 2001 under the Greenspan Fed and its ability to remedy the national economy through interest rate cuts and tax rebates. Due to the effects of this combination of monetary and fiscal policy, Green argues that a more drastic implementation of such actions that is currently underway will be able to help the current economy in a recession recover in the same manner, if not in a shorter period of time. Such confidence in Green’s outlook is based upon the success the course of action has had in previous recessions, and his reasoning provides that since rates are being cut more aggressively and a more generous stimulus package is being created to promote consumption spending, that GDP will grow higher and at a faster rate compared to 1991 and 2001. The problem is that Green’s optimism does not take into consideration other factors so seriously, dismissing them as “weak economic data”; but for example, the national economy has to be viewed with respect to the conditions of the global economy—a factor that could negate the measures that the government and Fed are currently taking. Not only that, but the rising inflation could have a significant impact on the course of the economy by affecting consumer confidence and the credibility of the Fed. The second article draws a detailed comparison of the 2001 and the current economic recession. It pays closer regard to the differences between Greenspan’s and Bernanke’s approaches to interest rate cuts and the economic trends, and also mentions the housing trend. Despite Green’s acknowledgement of the ailing condition of the housing market, he downplays its significance by noting that it only accounts for 4.2% of real GDP. The small percentage that it embodies, however, has large implications such as consumers’ perceived wealth which is tied to their behavior in saving and consumer spending.

Yanik Jayaram

Dick Green is proposing that our economy, despite what the news is gloomily projecting, is likely to improve from it's current situation. From the two articles presented, I believe his main points were as follows:
In his first article, Green makes the following arguments for why we don't need to worry:
1) Our interest rate decrease by the Fed should increase investment and boost GDP- we simply have to wait out the 9 month lag for them to take effect. -- This argument fits with our model, which tells us that, as Interest rates are cut, Investment will increase, adding to overall GDP.
2) There are historical similarities to todays recession and that of 2001's, and the recession of 2001 was relatively mild in comparison to historical recessions. Given that, and the fact that we have acted sooner in fighting this recession, there isn't much to worry about. -- Our model does not take historical factors into account, so in this sense, Green has something new and interesting to contribute regarding ways to interpret an event in the economy. Should we just look at our simplified (yet powerful) model, or should we also consider the historian and political scientist's method of using the past to predict the future?

3) Fiscal stimulus policy (putting more money in the hands of the consumer) should boost the economy (produced a 7% boom in PCE in 2001), thus increasing consumer and business confidence, allowing for a rise in GDP. --This doesn't necessarily make sense in our model. This stimulus policy is essential a money transfer from Government consumption to Household consumption Since both add to GDP, why should this rebate increase GDP on net? Unless it gives businesses confidence to start investing and growing there businesses, I don't see why this is an effective plan. Why not just have the government spend it on businesses?

4) Overly-pessimistic speculators are a large explanation for what we hear in the news, and one should expect a turn around by July.- This makes sense in our model in that it fits the role of the "animal spirits" parameter in our investment equation.

In his second article, Green made more arguments supporting the same conclusion, this time by comparing the 2001 and 2008 recessions:

Differences in recession of 2001 vs. today:
1) The 2001 recession was caused by a downturn in business investment and output. The bubble caused companies to build an overcapacity of employment. Industrial production went negative before the recession of 2001, yet today, industrial production has not gone negative. In fact, it was up .3% in November and was flat in December. -- The fact that production is higher today than it was in 2001 is important, but doesn't help his argument if people aren't consuming that production. For example, look at the housing industry. If you have produce a ton of houses, but no-one is buying them, then you might count them as inventory in a business, but they aren't really contributing value to the economy.

2) Green also argues that the payroll decline, while similar to what happened in 2001, is still ambiguous. Also, the announced layoffs haven't surged in the way that they did in 2001- recessions in real GDP correlate with payroll declines of 150,000 to 200,000 a month, which we are not seeing today -- looking at the statistics, it seems like Green has a decent point, since the numbers of layoff are significantly lower today than they were in 2001- but maybe this is just because we haven't reached that stage yet.

3) Green also argues that housing is worse this time around than last, but asserts that the fact that it only accounts for 4.2% of real GDP means we don't have much to worry about in terms of it hurting our economy. --As someone earlier pointed out, 4.2% isn't a percentage to belittle. Recall that in 1970, when OPEC caused the tripling of oil prices, Real GDP in the U.S. plummeted to .6 percent per year (a loss in productivity of 25%), even though oil only accounted for 4% of costs. When a commodity that is used heavily by everyone becomes inaccessible to people, it has damaging impacts, regardless of whether we can see them directly or not.

4) Green also argues that the biggest difference between the 2001 recession and the recession today is how soon the Fed has cut interest rates. In the 2001 recession, the Fed didn't cut rates until January of 2001, which was after the recession had occurred. This time, the Fed cut rates four months before the recession hit. Since the lag in the effect of rate cuts is approximately 9 to 10 months, Green argues that we can expect to see an upward turn in the economy's GDP in July (the 3rd quarter). -- Our model doesn't account for lag, but as I said before, this does align with our model in terms of it resulting in an increase in investment, which adds to overall GDP.

Seung Eun Park

Green, at his first article argues that during 1991 and 2001 the fed rate started to cut off and after 9 months GDP has arised. Also government fiscal policy has raised the GDP. He concludes that this year the monetary and fiscal stimulus is significant and positively sure that GDP will increase also by historical evidence. Although his facts were evidencially true, he did not considered the whole affects on GDP, rather concentrated on 2 factors that do affect on GDP. During recession in 1991 and 2001, the governemnt would have improved economic status by policy, but there are other factors as Net Exports that partially caused the rise in economy. Green's theory could not be evidentially persuable without indicating other factors, and how other factors affect the whole economy.
On his second article, showing how buisness contraction, industrial production, employment trends, personal consumption and interest change over time during 2001 and concludes that the biggest difference is the trand in interest rate which was siginifically slowing down at a faster rate assums a strong boost to real GDP by the third of this year. In this artical lack of other factors and prediciting the future by one past year has limitation to conlcude for the future GDP. But his graphical analysis was providing a big help on his arguments.

Ben Bednarz

Green's idea is simple. He claims that we can look at the past and see how the previous goverment dealt with a recession (in this case the recession of 2001) and since history tends to repeat itself, that will give us an idea of how much a recession we will see in 2008.

Increasing consumer spending is definitely a nice idea, and a tax refund check is certainly a good way of doing it. Unfortunately, I don't think the government is looking at the long term consequences of such a decision. The government can't create money out of nothing; they have to get it from somewhere. Their solution is to borrrow more money to pay for these rebates. But by doing so, they create inflation in the long run. Imagine: the government has a billion dollars in war costs they want to finance. They finance this by selling government bonds and getting cash for them, and so in this means they borrow the billion dollars. They then spend it on the war, and put it back in the economy. The economy now has a billion dollars more in M3 floating around then it did before (anything type of money suppor indicator that includes government bonds). So the effective money supply goes up, and with that the price level. Thats whats going on with this rebate. The government effectively increases the money supply by a billion dollars and so inflation ensues; the government gives cash to the people by means of taxing everyone's cash holdings with an inflation tax. This only accomplishes two things:

1. redistrubutes wealth from creditors to debtors and from those that have heavy amounts of cash to those with heavy amounts of capital.

2. It creates the ILLUSION to your average Joe that he has more money to spend. This allows consumption to not decrease supposedly keeping the economy out of a recession.

Reason #2 is clearly why these tax refunds are being done, but I don't think getting people to spend more illusory money is necessarly the solution to growing the economy. After all, the money isn't really there, its just paper being printed off the print presses..

Michael Leung

In response to Ben's post, the government's stimulus package does not affect the money supply. That's confusing open-market operations with the issuance of government bonds. The impact of the stimulus package is a (further) reduction in government savings and an increase in consumer spending because it is a cash transfer from the government to households in real dollars, not inflated dollars.

Green makes a good case for dismissing much of the media's pessimism regarding the economy. He compares the recession today to the 2001 recession and notes in the first article that the government response was far more aggressive and in the second that economic trends are on the whole more positive than in 2001--business investment and output haven't declined; we have yet to see an announced layoff surge; consumer spending is still holding up. All this given that the 2001 recession was relatively mild.

Back in 2007 we were told that the dual problems of the subprime crisis and housing bubble could cause a depression. But the credit crunch seems to have had little effect on investment and consumer spending, and if it does, the Fed's aggressive rate cuts are sure to mitigate the impact in a few months' time. As for the housing bubble, the only piece of bad news compared to 2001 is that residental construction has seen a significant decline. Accounting for 4.2% of GDP, will that really be enough to cause a prolonged recession, given all the other economic trends? Probably not, as long as consumer spending and business trends stay the way they are.

Lisa Sweeney

Dick Green’s two articles explain why he believes the coming recession won’t be as hard on the economy as the previous two. As has been discussed above, he makes his point through analysis of Fed response times, rebate checks, indicators such as payroll cuts, and past business cycles. His discussion of the effects of the housing situation understates the roll it will play in the economy, in my opinion. It is true that consumption has stayed at a comfortable level without any alarming decreases, but relying only on the timing of past drops isn’t a strong enough argument to dismiss the possibility of a future decrease in consumption. He mentions that residential construction is only 4.2% of GDP, but neglects to mention the share of residential-related products such as home furnishings and other housing supplies. The end of the housing boom doesn’t only mean that construction has fallen, but that the accompanying surge of housing-related purchases needed for a new home will also have to come to an end. The decrease in these sales may not have been seen yet, but if it affects a large enough share of GDP it could contribute to a recession.

Eugene Kur

The articles written by Richard Green talk about the economy in the short run, which we have not talked about in class yet. It makes no sense to try and apply our long or medium run models to analyze the articles or the arguments presented in them. The long run deals with decade-long periods of times (not a period of at most a year), while the medium run assumes GDP is always at the full-employment equilibrium level (this is quite different from a recession, where GDP falls below this level).

That said, we did in fact learn that a reduction in taxes leads to an increase in consumption, which would lead to an increase in GDP, as long as we assume that Y=C+I+G+NX even in a non-equilibrium situation. Thus a decrease in GDP (or the rate of growth of GDP) could be overcome by increasing consumption through fiscal policy.

The other major policy Green refers to is the cutting of the Fed interest rates (which we have not yet covered in class). Assuming that the Fed interest rate is identical to the one that investors rely on to make their decisions, cutting the interest rates will lead to an increase in investment spending, according to the equation we developed in class. Increasing investment spending should boost GDP and help contribute to long-run economic growth (as the capital stock grows).

In conclusion, the ideas presented in the articles cannot be judged based on the models we developed in class, but with a few extra assumptions added to our models, the policies presented by Green would (according to our modified models) lead to an increase in GDP which would counteract a possible oncoming recession.

David Liu

Green compares the oncoming recession to the 2001 recession and the 1991 recession, using predictions for the future that are largely based on empirical observations rather than models that we use. His predictions have the advantage that everything he predicts has happened before, and by repeating past actions we can recreate past effects. Another advantage he over our mathematical model is that his observations take into account time: It takes 9 months for the fed's actions to reflect on the market, something that is not considered in our Full-Employment Flexible-Price Model.

One problem I had with his analysis is his dismissal of the falling housing market- As mentioned before, he does not give a number for just how much the residential housing market is falling, and the loss of a small portion of 4.2% is still relatively large compared to the 1.7% loss in GDP of the 2001 recession. The fall of the housing market has not caused a recession by itself, but it will certainly worsen the recession that is coming.

Overall, his analysis that the coming recession will be less strong than the previous one is valid if we believe his assumptions-
That businesses will respond to a cut in interest rates as much as it did in 2001, that the coefficient I_r did not change in the last seven years.
Consumer's propensity to consume is as high as it was in 2001, so the fiscal stimulus packages will have the same or a larger effect.

He seems to rely too much on history, saying that what happened before must happen again, when any number of things could have changed: for example, the housing problem that was not present last time. While his assumptions may not hold, he makes a good case that early action by the fed will ease the coming recession

Sanjay Nimbark Sugarek

Green's analysis is actually quite similar to our classroom methods insofar as he views current statistics in the light of previously collected data and established economic models.
The obvious difference is that he is not dealing with a "flexible-price" model. Rather, he focuses on the short-run, and fluctuations in real GDP Y, particularly recent recessions.
As far as the actual material, he seems on point in his emphasis on the Fed's quick reaction to a potential recession, which would reduce the severity of this problem, should it materialize.
However, I agree with some of the above posts in that his dismissal of the Housing market and the ambiguous conclusions he draws about consumption levels is worrysome. In doing so, he somewhat neglects and understates the main questions raised by those fearing recession. As mentioned above, the tanking of the Housing market will probably have effects on other markets, and affect the consumption/saving patterns of those implicated.
While patterns in consumer spending were more ominous in the period leading up to the 2001 recession, his postulate that consumption will "hold up" did not prove extremely convincing. For me, trends in consumption are too ambiguous to yield a strong inductive analysis, and, at this point, inspections into the issue of a potential recession diverge.

Amit Mookerjee

The two articles deal with the recession in 2001, the recession in 2008 and the contrasting methods the government has used to counteract them.
The debate between the use of models and the use of historical case studies is very interesting. To me it appears case studies go an inch wide and a mile deep. That is, if problems of a similar nature were solved in some manner in the past it is likely the same solutions will work this time. However, the drawback of such an approach is that the experience is limited to a very specific situation. So while this may be the best solution to a given problem it is rare that two different circumstances are exactly the same.
The criticism one has for a model is that it is so general and so oversimplified that it can only provide general guidelines for making a decision. A model tend sto factor in a larger variety of variables.
The Fed's early attempts to fight the recession remind me of something that was stated in the book. As much as consumption, government spending, etc. affect an economy the economy is also subject to the expectations of its participants. A numerical analysis tells us a recession is approaching but it doesn't factor in teh reactions people will have to such news. Our models are unable to take into accoutnt he fact that people are in general fairly irrational and unpredictable.
The article doesn't address the differing circumstances under which the recession of 2001 and the recession of 2008 came about. A declien in potential output is symptom of some illness and I worry about the Fed immediately treating a cut in the interest rate as a cure all for any economic problem.
However, according to our models the Fed's moves will have the desired effect, so it seems like the arguments int he articles are correct.

I hope it works!

Yusuf Amir-Ebrahimi

In the first article, Green uses the interest rate and tax rebates to focus his analysis of the economic downturn. He posits that lowering the interest rates gets investment spending on the right track to correct a recession. Meanwhile, he believes that an economic stimulus package (i.e. tax rebates) works to relieve short term consequences of the economies current state. In the second article, Green strikes a comparison between today's recessing economy and the 2001 recession. Again, Green boils this issue down to the interest rate, but considers other factors. Payroll trends definitely look interesting is analyzing this recession, but he claims that the trends are not really related because core business trends have not changed significantly. His main line of evidence is history. Since these tactics worked in the past, he believes that they should work now. Moreover, he states that they will be even more effective because the economy is much better off than it was when Greenspan took charge of the Fed and because Bernanke is being aggressive in implementing these policies immediately. Though he makes a very convincing argument from the perspective of an analyst, he hasn't actually relied on economic principals for his explanation -- at least not the principals we use in this class. Instead of talking about technological growth or labor force increases, he speaks in terms of transfer payments (for economic stimulus) and the interest rate. These of course have a significant impact on the economy, but they are not direct factors of economic growth. This is likely why Green must rely on history for his argument, there is no model built around the interest rate and tax rebates.

Dmitri Krupnov

As somebody above has already mentioned, Richard Green is concerned mainly with the economy in the short run. In the flexible price model we have been studying for the past 2 weeks, we assume that the economy is at full employment and that potential output equals actual output. This is currently not the case in our economy, due to the recent housing and credit crises. Due to these problems, the labor markets do not clear. In Green’s analysis, he is concerned about unemployment levels within a period of about two years. This, in turn, has an effect on consumption. But notice that in our model, C = Co + Cy(1-t)Y, unemployment plays no part. The only case you can make is that consumer confidence is low, thus affecting Co. However, in the medium run, Y is a constant, so it has no effect on consumption. According to our model, the people who are forced out of their jobs (construction, in our case) will find another job in the medium run. Things would tend to go to equilibrium in the medium run, theoretically, and the short term unemployment does not concern us at this point of the course. Of course, the changes that the government makes does affect the medium and long run. An decrease in taxes will boost consumption C and a decrease in investment rate r should boost investment spending I in our model, while affecting net exports. And in the long run, this impetus will probably do more harm than good by increasing the budget deficit. But Green is not concerned about that in the article.

Benjamin Turk

In these two articles Green talks about some differences between the governments fiscal policy reactions to the 2001 and the now 2008 recession. The main difference seems to be that in this recent 2008 recession the reaction was bigger and faster. In response to this recession interest rates were cut faster and also bigger tax cuts were sent out. Green's assumption that these things will be more effective because they were quicker and bigger than 2001 may not be right. Sure they would be if people had the same marginal propencity to consume, but how can something that big just be assumed away.

Diana Lee

As noted in many of the posts above, the changes that Green talks about occur in the short-run economy so we cannot directly compare the flexible-price model with his predictions. Specifically, Green talks about the growth of real GDP while our model assumes that it is constant, and our model also assumes full employment. We can, however, compare some of Green's predictions with the general idea of our model. Both indicate that a decrease in interest rates should increase investment and thus boost the overall level of the economy. One thing I am confused about is how the Fed sets the interest rate (as noted above, it is not through inflationary policy). In Green's analysis, the interest rate is exogenous and determined by the Fed, whereas in the flexible-price model, the interest rate is the mechanism that adjusts in response to other changes to keep the economy in equilibrium. I don't understand how both of these can be true (given that the nominal interest rate set by the Fed is related to the real interest rate).

I find it interesting that many of the posts above noted that Green failed to emphasize and address the different causes of the two recessions. Namely, people note the importance that this recession is associated with a housing market bust and loan crisis, while the 2001 recession was caused by overly optimistic investors in the years previous. In thinking about the model that we have, it seems to me that there is no real differentiation to capture these different causes, but that both would show up as decreasing consumption and investment. Aside from different magnitudes in 2001 and 2008, I am curious to know whether the differences in causes really matters significantly in the end since they generally seem to work through the same mechanism.

Zhihui Zhang

It seems that the main point of Green's article is that the 2008 recession will not be as bad as the 2001 recession. Partially the reason for this is that Bernanke started cutting interest rates months before the 'start' of the recession compared to Greenspan back in 2001. He mentions several concerns, but states that they will not be be that big a factor. But as someone mentioned, although housing accounts for 4.2% of GDP (which I would also argue is not a small enough share to be simply dismissed), other industries (such as the home appliance industry) will be affected as well by the housing slump.

And while he mentions that "Factory orders and industrial production are (believe it or not) at record levels," I'm curious as to what the historical rate of change on these two factors are and over what period are they 'record levels'. You can see the data in the charts he presents on the other article and the rate of growth on Factory orders seemed to have decreased significantly towards late 2007, which despite being at 'record levels', seems to be a bad sign in my opinion.

Andrew Nhieu

Green shows in his two articles that a recession, if it occurs, would not be as bad as the recessions that we have had before. Bernanke is much more trigger-happy when it comes to cutting interest rates, a key to ending the previous recessions. Green states how since interest rates are being cut much earlier than before, we should be seeing the effects in the third quarter, instead of the fourth as we have seen in the past. Does what Green is saying hold up to what we are learning in class? Well, maybe and maybe not. In class, we “ruthlessly simplified” in our class to deal with what is happening in the real world. However, the real world is not that simple. For example, in the models we use we make many assumptions in order to make things easier. We keep variables such as total output and capital fixed in our models, something that is definitely not observed in the real world. In his articles, Green also makes some assumptions. For example, he assumes that the housing market will have a small effect on what happens because it is only four percent of gross domestic product. Other people though may view it as large, and he does not take in to the correlation the housing market has with other sectors. So, basically, everyone is making assumptions, and we can never truly know what is going to happen until it does. Our models are relatively agreeable with Green’s articles, but everyone is basing their views on subjective assumptions.

The comments to this entry are closed.