Lecture 2 - End of Overview of US Economy

Business cycles

We'll talk about these in the last 3 weeks of the course.

Create a model to explain boom and bust cycles. What can gov'ts do to smooth out the cycles? And are those actions effective. What can we learn from history - great depression, japan? What is similar, what is different? We don't have a lot of experience dealing with situations of deflation.

Fiscal policy vs. monetary policy - we will discuss later.

Ben Bernanke is much quicker to respond with fiscal policy changes. He learned a lesson from the Japanese who responded with "too little, too late".

In the modern period, cycles are much more moderate. Benign business cycles. Investors have become complacent.

Inflation and unemployment typically move in opposite direction of the business cycle.

Recently, the typical recession typically lasts less than one year. This makes it difficult for monetary policy makers because their policy changes don't have an effect for about a year. Therefore, they need to be predictive in their policies, which of course is very difficult to do.

There's a narrow time window to react and a long time lapse before policy changes have and effect.

New, more direct approaches are being tried now - not just cutting interest rates. Direct borrowing from the Fed. 28 days instead of overnight.

Lessons from 18 past banking crises
We'll talk about these at the end of the course

5 big crises and 13 more benign crises, including the 1984 Savings and Loan crisis in the US.

The 1984 S&L crisis was caused, in part, by high inflation rates because no one would deposit in the S&L unless they got interest higher than inflation. But long-term mortgage loans had already been written at relatively low rates.

Each crisis is different, but they tend to take similar paths.

What will happen with this current crisis? We seem to be following the path of a minor crisis.

Closing Remarks on the US Economy

This recession may be more serious than the 2001 stock market bubble burst because of multiple bad things happening simultaneously: housing, banks, inflation

We can learn from the Japanese experience and not make the same mistakes. If we're successful, we can avoid a prolonged slump.

Fed can't keep cutting interest rate. It would cause inflation and devaluing of the dollar.

If house prices fall much further, the Fed may not be in a position to help to stabilize losses.