Macro Lecture 15: Current Recovery

Transcription

1 Macro Lecture 15: Current Recovery Review: Late 2000 s Figures 15.1 and 15.2 review the fall in home prices and their effect on consumer and business confidence Real Price of Single Family Homes ($1,000): Figure 15.1: Real price of single family homes: Many homeowners were unable to make their mortgage payments ã é Homeowners were evicted MBSs could not make their payments Banks teeter on bankruptcy and their stock price tumble Consumer confidence falls Business confidence falls University of Michigan Index of Consumer Sentiment OECD Manufacturing Confidence Indicators for U.S Figure 15.2: Consumer sentiment and business confidence: Jan 2006-Jan 2009

2 2 Table 15.1 reports the relevant statistics for the late 2000 s; figure 12.1 illustrates the equilibria: Unemp Real Actual Infl Expected Infl Govt Year Rate (%) GDP Rate (%) Rate (%) Purch , , , , , ,090 Table 15.1: Late 2000 s macro data: AS AS AS AD AD ,400 14,500 14,600 Figure 15.3: Late 2000 s: AD ,700 14,800 14,900 15,000 Aggregate Supply (AS) Curve Applying the adaptive expectations principle we conclude that the expected inflation rate fell from 3.1 to 2.7 to 2.0 percent. Consequently, the aggregate supply (AS) curve shifted down because the expected inflation rate fell as illustrated in figure Aggregate Demand (AD) Curve The modest increase in government purchases was offset by the loss of business and consumer confidence resulting in a leftward shift of the aggregate demand (AD) curve. Government s Response Recall that in an effort to shift the aggregate demand curve back to the right, the Federal government responded in three ways as shown in figure 15.4: Troubled Asset Relief Program (TARP) American Recovery and Reinvestment Act of 2009 (Stimulus Bill) Quantitative Easing (QE1, QE2, and QE3) We will now consider TARP and the Stimulus Bill. AS AD AD Figure 15.4: Policy maker s goal

3 3 Troubled Asset Relief Fund (TARP): A $450 billion program designed to shore up the financial system. Recall that as a consequence of the home mortgage crisis, banks saw the value of their stock plummet. As shown in figure 15.5, Citigroup s stock fell dramatically when home prices fell Citigroup Closing Stock Prices TARP included three main parts, the purchase of stock, the purchase of MBSs, and the purchase of whole loans by the U.S. Treasury: Stock: U.S. Treasury purchases newly issued (preferred) stock from financial institutions. Mortgage-Backed Securities: U.S. Treasury identifies troubled MBS s and purchases them at a market price that accounts for their risk. Whole Loans: U.S. Treasury identifies troubled whole loans and purchases them at a market price that accounts for their risk. More than half of the funds were used to purchase stock. Table 15.2 focuses on these purchases: 0 Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Figure 15.5: Citigroup stock price: Jan 2006-Jan 2009 Preferred Stock Purchases by U.S. Treasury (billions $) Repaid TARP money (billions $) Company Citigroup (Some in common stock.) Bank of America AIG JPMorgan Chase Wells Fargo GMAC Financial Services (Ally) General Motors (Some in stock.) Goldman Sachs Morgan Stanley PNC Financial Services Group U.S. Bancorp Chrysler Capital One Financial Regions Financial Corporation American Express Bank of New York Mellon State Street Corporation Discover Financial Table 15.2: TARP stock purchases 1 Most of the large TARP purchases were made to buy stock from financial institutions: Citigroup, Bank of America, AIG, JPMorgan Chase, Wells Fargo, etc. 1 Data from Wikipedia.

4 4 To understand how this affected the bank s balance sheet review our example from the last lecture. As we saw before, in rhw fall of 2008 many of the MBSs became virtually worthless because home owners defaluted on their mortgages: Fall 2008: Assets Liabilities Reserves 50 Deposits 500 Vault Cash 30 Dep at Fed 20 Securities 70 Stock&Bonds 60 MBS 10 Loans 440 Borrowing 10 Elaine 20 Total Assets 560 Total Liabilities 510 Net Worth = Total Assets Total Liabilities = = 50 Now consider the U.S. Treasury s purchase of stock under the TARP program. See figure Question: How did the U.S. Treasury pay for the stock purchases? Answer: By writing a U.S. Treasury check made out to the bank. Question: What does the bank do with the U.S. Treasury check? Answer: Deposit it at its bank, the Federal Reserve Board. Citigroup Bank deposits the Treasury s check at the Fed. Citigroup Stock U.S. Treasury Washington, DC Pay to the order of Bank X Jacob Lew U.S. Treasury Check $10 U.S. Treasury Fed returns the Treasury s check to the Treasury Fed To understand how the bank s balance sheet will be affect by TARP, suppose that the U.S. Treasury purchased $10 of stock from the bank: Bank s deposits at Fed rise by $5. Figure 15.6: U.S. Treasury purchases $10 of Citigroup stock Early 2009: Bank receives TARP assistance of 10. Assets Liabilities Reserves Deposits 500 Vault Cash 30 Dep at Fed Securities 70 Stock&Bonds 60 MBS 10 Loans 440 Borrowing 10 Elaine 20 Total Assets Total Liabilities 510 Net Worth = Total Assets Total Liabilities = = In our example, the bank s deposits at the Fed rose by 10 as a consequence of the TARP assistance. Since deposits at the Fed are an asset of the bank, assets rise by 10. The bank s net worth increases by 10 from 50 to 60 thereby increasing the value of its stock.

5 5 Figure 15.7 reports on the stock price of Citigroup during this period: 600 Citigroup Closing Stock Prices Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Figure 15.7: Citigroup stock price: Jan 2006-Jan 2011 Many economists believe that TARP played an important role in FP stabilizing the stock of Citigroup and other banks. The goal of these stock purchases was to keep the major banks AD solvent thereby stemming the erosion of AD consumer and business r (%) confidence that the Figure 15.8: Resurgence in consumer and business confidence economy experienced from 2007 to Just as we showed that a decline in consumer and business confidence would shift the aggregate demand (AD) curves left, a rise in consumer and business confidence would shift the aggregate demand (AD) curves right as shown in figure 15.8.

6 6 American Recovery and Reinvestment Act of 2009 (Stimulus Bill) The Stimulus bill was enacted on February 17, In total it cost the Federal government approximately $800 billion. The provisions costing $14 billion or more follow (Data from Wikipedia.): Tax incentives for individuals: $237 billion o $116 billion: New payroll tax credit of $400 per worker and $800 per couple in 2009 and Phase out begins at $75,000 for individuals and $150,000 for joint filers. o $70 billion: Alternative minimum tax: a one year increase in AMT floor to $70,950 for joint filers for o $15 billion: Expansion of child tax credit: A $1,000 credit to more families (even those that do not make enough money to pay income taxes). o $14 billion: Expanded college credit to provide a $2,500 expanded tax credit for college tuition and related expenses for 2009 and The credit is phased out for couples making more than $160,000. Tax incentives for companies: $51 billion o $15 billion: Allowing companies to use current losses to offset profits made in the previous five years, instead of two, making them eligible for tax refunds. Healthcare: $155.1 billion o $86.8 billion for Medicaid o $25.8 billion for health information technology investments and incentive payments o $25.1 billion to provide a 65 percent subsidy of health care insurance premiums for the unemployed under the COBRA program Education: $100 billion o $53.6 billion in aid to local school districts to prevent layoffs and cutbacks, with flexibility to use the funds for school modernization and repair (State Fiscal Stabilization Fund) o $15.6 billion to increase Pell Grants from $4,731 to $5,350 Aid to low income workers, unemployed and retirees: $82.2 billion o $40 billion to provide extended unemployment benefits through Dec. 31, and increase them by $25 a week o $19.9 billion for the Food Stamp Program o $14.2 billion to give one-time $250 payments to Social Security recipients, people on Supplemental Security Income, and veterans receiving disability and pensions. Infrastructure Investment: $105.3 billion o $27.5 billion for highway and bridge construction projects Water, sewage, environment, and public lands: $18 billion Energy Infrastructure: $21.5 billion Energy efficiency and renewable energy research and investment: $27.2 billion Housing: $14.7 billion These programs increased government purchases and reduced taxes. As we know, these expansionary fiscal policies shift the aggregate demand (AD) curves right as shown in figure FP AD r (%) Figure 15.9: Resurgence in consumer and business confidence AD