J. Bradford DeLong: August 28, 2009
Principles of Macroeconomics: Outline J. Bradford DeLong University of California at Berkeley and NBER delong@econ.berkeley.edu August 28, 2009
Goal: the first macro principles that: • • • •
Actually helps people understand the New York Times Actually helps people understand why we are in a deep recession Differentiates sharply between normal economics and depression economics Points out that laissez-faire is simply not a live option
Financial markets: • • • •
Pool savings Oversee managers Share risks Stocks, bonds, preferred, class B, convertible, puts, calls, swaps, CDOs
Financial markets never subject to laissez-faire: • •
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Not since 1825 at least Even the most hands-off government is hands-on where finance is concerned • Or regrets it badly • Not even Milton Friedman applied laissez-faire to financial markets Market prices of financial assets are too important to be left to the market
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J. Bradford DeLong: August 28, 2009
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Governments have decided they must manage the flow of spending Managing financial asset prices is the best way they have found to do that
Total spending: • • • • •
Consumption spending by households Investment spending by businesses seeking to maintain or extend capacity Government purchases by the government Exports by foreigners Balancing item: minus imports
Federal Reserve affects spending: • • • • •
When Federal Reserve raises asset prices, spending goes up When Federal Reserve losers asset prices, spending goes down Federal Reserve affects asset prices by buying and selling bonds Supply and demand: lower supply of bonds means higher prices High bond prices mean high stock and real estate prices as well • Businesses can raise money on easy terms and spend to expand • Households feel rich and spend to consume • Also: when Fed buys bonds for cash, cash burns holes in people’s pockets
Spending, capacity, and prices: • • • • •
Compare spending and capacity Businesses post their prices • Depending on their expectations If spending greater than capacity, we have inflation If spending less than capacity, we have deflation Not on-off—conditions shade by sectors, regions, firms
Normal inflation economics: • • •
When spending is more than capacity Businesses twist arms to get workers to work more Businesses raise prices because the demand is there
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J. Bradford DeLong: August 28, 2009
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Businesses raise wages as they bid workers away from other businesses Prices and wages rise faster than expected Production, demand, and employment are high
Normal deflation economics: • • •
• •
When spending is less than capacity Businesses find that they have a hard time selling what they make And here we have to get behavioral (Bewley) • Cutting people’s wages makes them angry • Low morale—and low productivity • Better (from the firm’s point of view) to fire some people • The people who are fired are really mad—but they are no longer around • ”You cannot deflate a modern economy without mass unemployment” Hence pronounced asymmetry Should we make wages more flexible on the downside? • Smash unions, etc.? • Need to be careful—could tip us into depression (Fisher, Viner)
Managing the economy in normal times: • • •
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Even in normal times the government manages the macroeconomy The Federal Reserve tries to hit the “sweet spot” What if the Federal Reserve gets a reputation for inflation? • People’s expectations change • People expect inflation to be higher than they expect • You can see how this might cause a problem What if the Federal Reserve hits on the low side? • Lots of pointless high unemployment This is not easy
Fiscal and monetary policy in normal times: • • •
Federal Reserve’s decision-actin loop is shorter than congress’s Federal Reserve is still trying to hit the sweetspot So—in normal times—Federal Reserve tries to hit the “sweet spot”
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J. Bradford DeLong: August 28, 2009
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And so moves to undo whatever congress and the president do How did the Fed acquire and how does it use its technocratic power>
Abnormal economics: • •
Hyperinflation economics—which we won’t cover Depression economics—which we will cover
Depression economics: • • •
Asset prices control spending Risky assets sell for lower prices than safe one—the risk tolerance of the market What happens if the risk tolerance of the private market suddenly collapses?
Panics and crashes • • • • • •
Risk tolerance collapses Prices of risky assets fall Risk bearers are now poor—and want to bear even less risk Prices of risky assets fall further, etc. Businesses can’t raise money to expand—or even continue operations Households feel poor—and scared
The limits of normal monetary policy • • • • •
Open market operations—cash for short-term Treasuries What happens when you get short-term Treasury interest rates down to zero? Further operations are simply swapping zero-yield government liabilities You can’t push discount bond prices above par And if that isn’t enough to restore spending to full employment levels...
What can you do when crash and depression hit?—get us out of here... •
There are three forms of “extreme” macroeconomic policy • Fiscal policy • Banking policy
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J. Bradford DeLong: August 28, 2009
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• ”Quantitative easing” policy Drawbacks of extreme macroeconomic policy Effectiveness of extreme macroeconomic policy Political blockages to extreme macroeconomic policy
What can you do before crash and depression hit?—don’t go there... • • • • • • •
Manias... Get behavioral again... The Greenspan docttrine—clean up the mess afterwards It looked pretty good after 1987, 1991, 1997, 1998, and 2000 It looks much less good now ”Take away the punchbowl” Regulate financial markets smartly
863 words This draft: August 28, 2009 First draft: May 11, 2009
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