The Economic Crisis of 2008

Transcription

1 The Economic Crisis of 2008 Past, Present, and Future James Gwartney The Economics and Mathematics of the Global Financial Crisis University of Tennessee Chattanooga June 7, 2010

2 Three Key Events Lessons From Three Key Events Great Depression of the 1930s Great Recession of The Japanese experience of the 1990s Stories Matter Understanding the events of history influences the nature of future policy Slide 2 of 75

3 The Story of the Great Depression Myth Caused by 1929 stock market crash Reflects instability of markets New Deal government intervention brought depression to an end Reality Caused by monetary contraction Smoot-Hawley Tariff Act and tax rate increases Length and severity increased by New Deal policies 17% unemployment in 1939 Slide 3 of 75

4 The Great Depression Slide 4 of 75

5 The Great Depression was a time of high unemployment, soup lines, and banking panics. Slide 5 of 75

6 Exhibit 1.1: Real GDP, Real GDP plunged during After a recovery during , real GDP fell again in 1938 Real GDP Growth Real GDP Growth Rate (percent) Source: Data for 1929 is from Copeland, Morris A. How Large Is Our National Income? Journal of Political Economy. Vol 40 No. 6. Slide 6 of 75

7 Exhibit 1.2: Rate of Unemployment, The rate of unemployment rose from 3.2% in 1929 to 8.7% in 1930 and 15.9% in 1931 In , the unemployment rate soared to nearly one-quarter of the labor force After declining to 14.3% in 1937, the rate of unemployment rose to 19% in 1938 and it stood at 17% in 1939, a decade after the catastrophic decline began 30 Unemployment Rate Unemployment Rate (percent) Source: Slide 7 of 75

8 Was the Great Depression Caused by the 1929 Stock Market Crash? Slide 8 of 75

9 Exhibit 1.3: Stock Market, Stock prices plunged in September-October 1929 But they recovered during the five months from mid-november 1929 through mid-april of 1930 However, they continued on a downward path during May and for the rest of Why? 400 Dow Jones Industrial Average, Smoot-Hawley Debated and Passed 300 DJIA Jan-28 Jul-28 Jan-29 Jul-29 Jan-30 Jul-30 Source: and Slide 9 of 75

10 Exhibit 1.4: Stock Market, The Dow continued to fall throughout 1931 and 1932 There was a sharp rebound in stock prices during 1933 But the Dow never reached 200 throughout the remainder of the decade 400 Dow Jones Industrial Average, DJIA Source: and Slide 10 of 75

11 Stock Prices and Recessions The 1929 decline in stock prices reduced wealth, aggregate demand, and real output Stock prices have fallen by 50% or more during other recessions, but the economy still moved toward a recovery within a year or two While the decline in stock prices may have triggered the initial economic decline, the length and severity of the Great Depression were the result of other factors Slide 11 of 75

12 Why Was the Great Depression So Lengthy and Severe? Slide 12 of 75

13 Causes of the Great Depression The length and severity of the Great Depression were the result of four major policy mistakes: Contraction in the money supply Large increase in tariffs Huge tax increases in 1932 and again in 1936 Price controls, perverse regulations, and constant policy changes during the New Deal era Slide 13 of 75

14 Causes of the Great Depression Factor 1: Contraction of the Money Supply The supply of money expanded slowly but steadily throughout the 1920s Even though prices were relatively stable in the 1920s, the Fed increased the discount rate, four times between January 1928 and August 1929, pushing it from 3.5% to 6% After the October stock market crash, the Fed aggressively sold government bonds, which drained reserves from the banking system and reduced the money supply Slide 14 of 75

15 Exhibit 2.1: Change in the Money Supply, The money supply fell by 3.9% during 1930, by 15.3% in 1931, and by 8.9% in 1932 The quantity of money at year-end 1933 was 33% less than in 1929 The money supply increased during , but dipped again in Annual Change of the M1 Money Supply, Change in M1 Money Supply (percent) Source: Change in the money supply is from December to December. The data is from: Friedman, Milton and Schwartz, Anna J A Monetary History of the United States, Princeton; Princeton University Press. Slide 15 of 75

16 Exhibit 2.2: Change in Consumer Prices, The monetary contraction during led to deflation The deflation changed the terms of loans, investments, and other economic activities that take place across time periods 6.0 Annual Change in Consumer Price Index, Change in Consumer Price Index (percent) Source: Slide 16 of 75

17 Monetary Policy and the Great Depression Sound monetary policy is about monetary and price stability The Fed failed during the 1930s: The initial monetary contraction during plunged the economy into recession and the second monetary contraction during stifled the prospects for recovery The monetary instability of the 1930s generated uncertainty and undermined the exchange process Slide 17 of 75

18 Causes of the Great Depression Factor 2: Smoot-Hawley Tariff Increases of 1930 Legislation passed in June 1930, increased tariffs by more than 50% on approximately 3,200 imported products Like proponents of trade restrictions today, the Smoot-Hawley supporters argued the bill would save jobs I want to see American workers employed producing American goods for American consumption Rep. Willis Hawley Slide 18 of 75

19 Sen. Reid Smoot (R) and Rep. Willis (L) Hawley thought their tariff increases would save jobs. Instead, they reduced output and plunged the economy deeper into recession Slide 19 of 75

20 Causes of the Great Depression Impact of Smoot-Hawley The stock market, which had rebounded to levels prior to the October 1929 crash, moved steadily downward as Congress debated and passed the Smoot-Hawley bill Sixty countries responded with higher tariffs on American exports and the volume of trade fell by more than 50% Smoot-Hawley reduced the gains from specialization and trade, generated less tariff revenue even though the rates were higher, and plunged the economy further into recession The unemployment rate was 7.8% when Smoot-Hawley was passed, but it ballooned to 23.6% just two years later Slide 20 of 75

21 Causes of the Great Depression Factor 3: Tax Increases in the Midst of a Severe Downturn As the Federal budget fell into deficit in 1931, Congress and the Hoover Administration instituted a huge tax increase in order to balance the budget This tax increase reduced aggregate demand and the incentive to earn and invest, plunging the economy still deeper into recession Slide 21 of 75

22 Exhibit 3.1: Marginal Income Tax Rates, The top marginal income tax rate was increased from 25% in 1931 to 63% in 1932 other rates were increased by a similar amount In 1932, real GDP fell by 13.3% and the unemployment rate soared to nearly a quarter of the labor force 90 Top and Bottom Marginal Income Tax Rates, Marginal Income Tax Rate (percent) Top Marginal Rate Lowest Marginal Rate Top Marginal Rate Lowest Marginal Rate Source: The Tax Foundation, and the IRS at Slide 22 of 75

23 Exhibit 3.1: Marginal Income Tax Rates, The top marginal rate was pushed still higher to 79% in 1936, and the tax on the retained earnings of business was also sharply increased These tax hikes contributed to the recession of Top and Bottom Marginal Income Tax Rates, Marginal Income Tax Rate (percent) Top Marginal Rate Lowest Marginal Rate Top Marginal Rate Lowest Marginal Rate Source: The Tax Foundation, and the IRS at Slide 23 of 75

24 Causes of the Great Depression Factor 4: Price Controls, Regulations, and Constant Policy Changes Many history books credit New Deal policies with the eventual end of the Great Depression Some New Deal policies were helpful: The Federal Deposit Insurance Corporation Re-evaluation of gold and the expansion in the money supply during But other policies were harmful, and increased the length and severity of the Great Depression Slide 24 of 75

25 The Agricultural Adjustment Act (AAA) Under the AAA, adopted in 1933, the Roosevelt Administration tried to push prices up by reducing supply Farmers were paid to plow under portions of cotton, corn, wheat, and other crops Potato farmers were paid to spray their potatoes with dye so they would be unfit for human consumption Cattle, sheep, and pigs were slaughtered AAA was declared unconstitutional in 1936 Slide 25 of 75

26 In an effort to push farm prices up, 6 million pigs were slaughtered under the AAA in 1933 alone. Slide 26 of 75

27 The National Industrial Recovery Act (NIRA) Under this legislation passed in June 1933: More than 500 industries ranging from automobiles and steel to dog food and dry cleaners were organized into cartels Government and business leaders set production quotas, prices, wages, working hours, and distribution methods for each industry Once approved by a majority of the firms, the regulations were legally binding on all of the firms in the industry Businesses that did not comply were fined and subject to jail sentences Prior to this legislation, price fixing of this type would have been a violation of anti-trust legislation All of this reduced competition, promoted monopoly pricing, and undermined the market process Slide 27 of 75

28 Exhibit 4.1: NIRA Industrial Production, Industrial output increased sharply during April-July 1933 When the NIRA was implemented in July, industrial output fell by more than 25% over the next 6 months Output never reached the June 1933 level again until after the NIRA was declared unconstitutional in May of U.S. Industrial Production, Index of Industrial Production NIRA passed NIRA is declared unconstitutional Source: Historical Statistics of the United States. The base period (equal to 100) was the average of the monthly figures during Slide 28 of 75

29 Lessons from the Great Depression Monetary contraction will undermine economic activity such as investment and thereby retard output and employment Trade restrictions will reduce the gains from specialization and exchange They will not save domestic jobs Instead they will lead to inefficient use of resources and reductions in output Raising taxes during a recession will reduce output and make matters worse Slide 29 of 75

30 Lessons from the Great Depression Constant policy changes will generate uncertainty, retard private investment, reduce business activity, and thereby prolong the depressed conditions Good intentions are no substitute for sound policies Key decision-makers such as Presidents Hoover and Roosevelt, Sen. Smoot, Rep. Hawley, other members of congress, and the monetary policy-makers of the 1930s had good intentions, but their actions tragically turned what would have been a recession into the Great Depression Slide 30 of 75

31 The Great Recession of Slide 31 of 75

32 The Story of the Great Recession Myth Caused by greed and excessive risk taking Regulators were asleep at the switch Markets are inherently unstable More regulation is the answer Reality Caused by policies that contaminated the mortgage market Regulations promoted subprime and low downpayment mortgages GSEs eroded incentive for mortgage originators to evaluate loan quality Fed policy promoted ARM loans Slide 32 of 75

33 Key Events of the Great Recession Housing price increase during , followed by a levelling off and price decline Increase in the default and foreclosure rates beginning in the second half of 2006 Collapse of major investment banks in collapse of stock prices Slide 33 of 75

34 Exhibit5.1: House Price Change Housing prices were relatively stable during the 1990s, but they began to rise toward the end of the decade. Between January 2002 and mid-year 2006, housing prices increased by a whopping 87 percent. The boom had turned to a bust, and the housing price declines continued throughout 2007 and By the third quarter of 2008, housing prices were approximately 25 percent below their 2006 peak. Annual Existing House Price Change 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% -20.0% Source: S and P Case-Schiller Housing Price Index. Slide 34 of 75

35 Exhibit 5.2: The Default Rate The default rate fluctuated, within a narrow range, around 2 percent prior to It increased only slightly during the recessions of 1982, 1990, and The rate began increasing sharply during the second half of It reached 5.2 percent during the third quarter of % Default Rate 5% 4% 3% 2% 1% 0% Source: mbaa.org, National Delinquency Survey. Slide 35 of 75

36 Exhibit 5.3: Foreclosure Rate The foreclosure rate fluctuated between 0.2% and 0.4% between 1979 to This indicates that only 2 to 4 mortgages per 1,000 ended up in foreclosure. As soon as housing prices levelled off and then began to fall, the foreclosure rate soared, reaching 1.2% in the 3 rd quarter of By 2009 the foreclosure rate rose to more than 2% and it was 5% or more in Arizona, California, Florida, and Nevada. 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% Foreclosure Rate 0.0% Source: National Delinquency Survey. Slide 36 of 75

37 Exhibit 5.4: Stock Market Returns As of mid-december of 2008, stock returns were down by 37 percent since the beginning of the year. This is nearly twice the magnitude of any year since This collapse eroded the wealth and endangered the retirement savings of many Americans. 60% 50% 40% 30% 20% 10% 0% -10% -20% S and P 500 Total Return -30% -40% Source: Slide 37 of 75

38 Four Key Factors Underlie Current Crisis 1. Erosion of conventional lending standards 2. Fed policy during Increased leverage lending of GSEs and investment banks 4. Increase in household debt to income ratio Slide 38 of 75

39 What Caused the Crisis of 2008? FACTOR 1: Beginning in the mid-1990s, government regulations began to erode the conventional lending standards. Fannie Mae and Freddie Mac hold a huge share of American mortgages. Beginning in 1995, HUD regulations required Fannie Mae and Freddie Mac to increase their holdings of loans to low and moderate income borrowers. HUD regulations imposed in 1999 required Fannie and Freddie to accept more loans with little or no down payment regulations stemming from an extension of the Community Reinvestment Act required banks to extend loans in proportion to the share of minority and low-income population in their market area. Conventional lending standards were reduced to meet these goals. Slide 39 of 75

40 Exhibit 6.1: Fannie Mae and Freddie Mac Share of Total Mortgages, The share of all mortgages held by Fannie Mae and Freddie Mac rose from 25 percent in 1990 to 45 percent in Their share has fluctuated modestly around 45 percent since % Fannie Mae and Freddie Mac, Share of Outstanding Mortgages 45% 40% 35% 30% 25% 20% Source: Office of Federal Housing Enterprise Oversight, Slide 40 of 75

41 Exhibit 6.2: Earnings of Fannie and Freddie, The net earnings of Fannie and Freddie were flat during the 1970s and 1980s. GSE net annual earnings rose from $2 billion in 1990 to $7 billion in 2000 and more than $15 billion in Combined Earnings of Fannie and Freddie, in Billions of 2009 Dollars Source: Roberts, Russell, Gambling with Other People s Money, Slide 41 of 75

42 Exhibit 6.3: GSE Mortgages to Borrowers with Incomes Below the Median, As the HUD regulations took affect in 1996, GSE mortgages to borrowers with incomes below the median soared. GSE Mortgage Loans to Below-Median-Income Borrowers Source: Roberts, Russell, Gambling with Other People s Money, Slide 42 of 75

43 Exhibit6.4: Contamination of the Mortgage Market Growth of Low Quality Mortgages Subprime, Alt-A and home equity loans have increased substantially as a share of the total since In 2006, subprime, Alt-A, and home equity loans accounted for almost half of the mortgages originated during the year. 50% Subprime, Alt-A, and Home Equity as a Share of Total 40% 30% 20% 10% 0% Subprime (FRB) Subprime (JCHS) Subprime + Alt-A Subprime + Alt-A + Home Equity Source: Data from is from the Federal Reserve Board while is from the Joint Center for Housing Studies at Harvard University Slide 43 of 75

44 Exhibit 6.5: Contamination of the Mortgage Market Growth of Low Down Payment Loans by GSEs The share of Fannie and Freddie mortgages with less than 5 percent down payment soared from 4 percent in 1998 to 12 percent in 2003 to 23 percent in 2007 Share of Fannie and Freddie Mortgages with Down Payment of Less Than 5%, Percent GSE Mortgages Source: Roberts, Russell, Gambling with Other People s Money, Slide 44 of 75

45 What Caused the Crisis of 2008? FACTOR 2: The Fed s manipulation of interest rates during Fed's prolonged Low-Interest Rate Policy of increased demand for, and price of, housing. The low short-term interest rates made adjustable rate loans with low down payments highly attractive. As the Fed pushed short-term interest rates upward in , adjustable rates were soon reset, monthly payment on these loans increased, housing prices began to fall, and defaults soared. Slide 45 of 75

46 Exhibit 7.1: Short-Term Interest Rates The Fed injected additional reserves and kept short-term interest rates at 2% or less throughout Due to rising inflation in 2005, the Fed pushed interest rates upward. Interest rates on adjustable rate mortgages rose and the default rate began to increase rapidly. 8% 7% 6% 5% 4% 3% 2% 1% Federal Funds Rate and 1-Year T-Bill Rate 0% Federal Funds 1 year T-bill Source: and Slide 46 of 75

47 Exhibit 7.2: Taylor Rule and Fed Policy, 1985-present Actual and Target Federal Funds Rate, 1985-present Percent Actual Target Source: Federal Reserve Bank of St. Louis Slide 47 of 75

48 Exhibit 7.3: Further Contamination of The Mortgage Market Growth of ARM Loans Following the Fed's low interest rate policy of , Adjustable Rate Mortgages (ARMs) increased sharply. Measured as a share of total mortgages outstanding, ARMs increased from 10% in 2000 to 21% in % ARM Loans as a Percent of Total Outstanding Mortgages 20% 15% 10% 5% 0% Source: Office of Federal Housing Enterprise Oversight, Slide 48 of 75

49 What Caused the Crisis of 2008? FACTOR 3: An SEC Rule change adopted in April 2004 led to highly leverage lending practices by investment banks and their quick demise when default rates increased. The rule favored lending for residential housing. Loans for residential housing could be leveraged by as much as 25 to 1, and as much as 60 to 1, when bundled together and financed with securities. Based on historical default rates, mortgage loans for residential housing were thought to be safe. But this was no longer true because regulations had seriously eroded the lending standards and the low interest rates of had increased the share of ARM loans with little or no down payment. When default rates increased in 2006 and 2007, the highly leveraged investment banks soon collapsed. Slide 49 of 75

50 Exhibit 8.1: Leverage Ratios The leverage ratios of loans and other investments to capital assets for various financial institutions are shown here. When Bear Stearns was acquired by JP Morgan Chase its leverage ratio was 33 to 1. Note, this was not particularly unusual for the GSEs and large investment banks. Leverage Ratios (June 2008) Freddie Mac 67.9 Fannie Mae 21.5 Brokers/hedge Funds 31.6 Savings institutions Commercial banks Credit unions Source: The Rise and Fall of the U.S. Mortgage and Credit Markets: A Comprehensive Analysis of the Meltdown, Milken Institute Slide 50 of 75

51 What Caused the Crisis of 2008? FACTOR 4: Doubling of the Debt/Income Ratio of Households since the mid-1980s. The debt-to-income ratio of households was generally between 45 and 60 percent for several decades prior to the mid 1980s. By 2007, the debt-toincome ratio of households had increased to 135 percent. Interest on household debt also increased substantially. Because interest on housing loans was tax deductible, households had an incentive to wrap more of their debt into housing loans. The heavy indebtedness of households meant they had no leeway to deal with unexpected expenses or rising mortgage payments. Slide 51 of 75

52 Exhibit 9.1: Household Debt as a Share of Income Between , household debt as a share of disposable (after-tax) income ranged from 40 percent to 60 percent. However, since the early 1980s, the debt-to-income ratio of households has been climbing at an alarming rate. It reached 135 percent in 2007, more than twice the level of the mid-1980s. 140% Household Debt to Disposable Personal Income Ratio 120% 100% 80% 60% 40% 20% Source: Slide 52 of 75

53 Exhibit 9.2: Debt Payments as a Share of Income Today, interest payments consume nearly 15 percent of the after-tax income of American households, up from about 10 percent in the early 1980s. 16% Debt Payments to Disposable Personal Income Ratios 14% 12% 10% 8% 6% Total Debt Mortgage Source: Slide 53 of 75

54 Summary of the Great Recession Regulations that eroded lending standards, the Fed s interest rate policy, imprudent leverage lending by banks with the help of security rating firms, and the growth of household debt combined to create the financial crisis of 2008 The mortgage-backed securities were marketed throughout the world, and as default rates rose, the value of the securities plummeted and the crisis spread around the world The default and foreclosure rates rose well before the recession started in December 2007, indicating that it was the housing crisis that caused the recession, not the other way around Slide 54 of 75

55 Lessons from the Japanese Experience Slide 55 of 75

56 The Boom and Bust of Japanese Asset Prices, The Japanese economy grew at an annual rate of 6% during the 3 decades following By 1990, the per-capita income of Japan was similar to the high-income countries of Western Europe and North America In the late 1980s, real estate and stock prices in Japan soared, much like housing prices in the U.S. during Like the housing boom in the U.S., Japan s stock and real estate price boom was followed by a bust in the early 1990s This price collapse led to a surge in loan defaults, troubles in the banking sector, and a sharp slowdown in the growth of the Japanese economy in the early 1990s This sluggishness persisted and the 1990s are now known as Japan s lost decade Slide 56 of 75

57 Exhibit10.1: Japanese Stock Market, During the 1980s the Nikkei 225 soared, reaching nearly 39,000 at year-end 1989 But it fell by 46% during the first 9 months of 1990 and has never recovered By January 2002, it had fallen below 10,000, approximately ¼ the 1989 level At year-end 2008 the index stood at 8,860 40,000 Nikkei 225 Index, ,000 Nikkei 225 Index 20,000 10, Source: finance.yahoo.com Slide 57 of 75

58 Exhibit10.2: Change in Real GDP, Growth of real GDP in Japan averaged 5% annually during the 1980s, but only 1% during Growth during has remained sluggish Change in Japanese Real GDP, Change in Real GDP (percent) Source: World Bank, World Development Indicators and OECD Economic Outlook, Dec 2008 No. 84 Slide 58 of 75

59 Exhibit10.3: Japanese Unemployment, The Japanese unemployment rate is quite low, but there has been an upward trend since 1992 Japanese Rate of Unemployment, Unemployment Rate (percent) Source: World Bank, World Development Indicators and OECD Economic Outlook, Dec 2008 No. 84 Slide 59 of 75

60 Japanese Policy Responses During the 1990s Slide 60 of 75

61 Japanese Fiscal Policy Japan responded to the downturn with several stimulus programs that substantially increased spending on roads, bridges, and other infrastructure Government spending rose from a little more than 30% of GDP in the early 1990s to nearly 40% in the latter part of the decade The increased spending was financed with budget deficits Slide 61 of 75

62 Exhibit11.1: Government Expenditures, During the 1990s, government spending expanded, soaring to nearly 40% of GDP during Japanese Government Expenditures as a Share of GDP, Government Expenditures As a Share of GDP (percent) Source: OECD Economic Outlook, June 2003 No. 73 Slide 62 of 75

63 Exhibit11.2: Japanese Budge Deficits, Japan s increased government spending was financed by borrowing Japan began running budget deficits in 1993, and they became larger and larger during the decade that followed 4.0 Japanese Budget Deficits as a Share of GDP, Budget Deficit (-) or Surplus (+) As a Share of GDP (percent) Source: OECD Economic Outlook, June 2003 No. 73 Slide 63 of 75

64 Exhibit11.3: Japanese Net Debt, Measured as a share of GDP, the net debt of the Japanese Central Government was 14% in 1992, but it rose to 60% in 2000 and 88% in 2008 Japan s fiscal policy response was highly expansionary an increase in government spending, larger budget deficits and an increase in debt But the economy continued to stagnate Net Debt of Japanese Central Government as a Share of GDP, Net Government Debt (percent of GDP) Source: OECD Economic Outlook, Dec 2008 No. 84 and June 2003 No. 73 Slide 64 of 75

65 Japanese Fiscal Response Summary Japan s fiscal policy response was highly expansionary Government spending as a share of GDP increased Budget deficits were large Net government debt soared But the economy continued to stagnate Slide 65 of 75

66 Japanese Monetary Policy In contrast with fiscal policy, Japanese monetary policy was restrictive during the 1990s The money supply grew slowly and during deflation was often present Slide 66 of 75

67 Exhibit12.1: Japanese Monetary Policy, In contrast with fiscal policy, Japanese monetary policy was restrictive during the 1990s The money supply grew slowly and during deflation was often present Change in M2 (percent) Annual Percentage Change in Japanese M2 Money Supply, Source: and OECD Economic Outlook, June 2003 No. 73 Slide 67 of 75

68 Exhibit12.2: Japanese Inflation, The general level of prices changed little during the 1990s Deflation was present during 5 of the 8 years between Annual Percentage Change in Japanese Consumer Price Index, Change in Consumer Price Index (percent) Source: and OECD Economic Outlook, June 2003 No. 73 Slide 68 of 75

69 The Aging Population of Japan in the 1990s and the United States Today Slide 69 of 75

70 Exhibit13.1: Aging of the Japanese Population The share of the population age 65 and over in Japan nearly doubled during Percentage of the Japanese Population Percent of Population Source: Statistical Survey Department of Japan, Statistics Bureau, Ministry of Internal Affairs and Communications; the National Institute of Population and Social Security Research, Slide 70 of 75

71 Exhibit13.2: Aging of the U.S. Population The elderly population in the U.S. during will grow rapidly, but the growth will be a little slower than was the case in Japan during Percentage of the U.S. Population Percent of Population Source: U.S. Census Bureau. The 2020 and 2030 figures for the U.S. are projections. Slide 71 of 75

72 Impact of Aging Population Growth of the elderly population as a share of the total, will tend to reduce productivity and lead to higher taxes for the finance of retirement benefits and health care for the elderly This slowed economic growth in Japan during the 1990s, and it is likely to do so in the U.S. in the decade ahead Slide 72 of 75

73 Lessons from the Japanese Experience Expansionary fiscal policy is unlikely to be very effective in promoting recovery from a severe recession generated by reductions in asset prices and wealth Restrictive monetary policy will tend to delay and complicate recovery Growth of the elderly population as a share of the total is likely to place upward pressure on taxes, reduce productivity, and slow long-term growth Slide 73 of 75

74 Difference Between Policy Response of Japan and the U.S. While there are many similarities between the Japanese economic crisis of 1990 and that of the U.S. in , there is one major difference: monetary policy If monetary policy exerts a strong impact, the U.S. experience in the decade ahead may differ substantially from that of Japan during the 1990s Even if expansionary monetary policy does lead to a robust recovery, the long and variable lags will make it difficult for the Fed to both promote recovery and then shift back to restraint in a manner that will lead to stability in the decade ahead We are in the midst of a very interesting experiment in macroeconomics Slide 74 of 75

75 END Slide 75 of 75