Growing Together

Growing Together Vanessa Rodriguez

Overview • The 5 W’s of the Great Recession • The Who, What, Where, When, and Why • Response solutions to the crisis • Prevention policies to avoid a relapse

How do we prevent another recession? • Figure out where things went wrong • Learn from our mistakes IN EVERY MISTAKE THERE IS A POTENTIAL FOR GROWTH

WHO contributed to the development of the recession? • Oil Shock • Oil prices skyrocketed from ~$75 to ~$146 per barrel from 2007 to 2008

WHO contributed to the development of the recession? • Food Shock • Food prices shot up from about $160 to $225 on the Food Price Index (FPI) from 2007 to 2008

WHO contributed to the development of the recession? • Worldwide Financial Market Crisis • Subprime mortgage crisis • Lehman Brothers investment bank failure

WHAT were the consequences? • Increase in oil and food prices • Led to consumer spending of other products to decrease C GDP GDP = C + I + G + NX

WHAT were the consequences? • Subprime mortgage crisis led to an even further decrease in consumer spending as well as a decrease in business investments I + C GDP GDP = C + I + G + NX

WHAT were the consequences? • Lehman Brothers investment bank failure led to a global banking panic C+ I + NXGDP GDP = C + I + G + NX

WHAT were the consequences?

WHERE did the crisis affect? All regions and countries were affected by the crisis “Great Recession” Figure 3: Real GDP growth in foreign countries prior to the recession Source: Michael Roberts, The Trader (October 2012)

WHERE did the crisis affect? Public debt AFTER the recession of various developed countries Figure 4: General government debt of developed countries due to the recession in 2010 Source: Carlo Cottarelli, Director of the Fiscal Affairs Department (January 2012)

WHEN did these problems start emerging? • 1980’s: Reappraisal of regulations set forth after the Great Depression • From this date until 2007 many problems began to arise: • Banking deregulation • Household saving rates decreased • House price boom • 2007: Food and oil prices increased sharply over a short period of time of about one year

WHY were these problems not prevented or stopped on time? Financial deregulation: • Policies were no longer necessary • Monetary policy was thought to prevent another recession • Policy reappraisal led to a healthy economy no signs of threat to the future economy were apparent Oil & Food shocks: • Similar events happened in the past and they corrected themselves • Economists ignored these issues and focused on alleviating other economic problems

Response solutions to the crisis Governments gave financial support to their banks • FAILED to stimulate consumer & business spending temporary relief to banks Governments implemented fiscal policies • SUCCESS in the long run stimulated demand even though it increased public debt (i.e. government spending) Monetary policies by major central banks • FAILED in the short run did not ease the credit crisis

How do we prevent another recession? • Unemployment rate low (i.e. full employment) • Low inflation (i.e. optimal inflation target) • Economic growth

Keep AD constant Control: • Consumer spending • Business investments • Exports

Generate budget surplus • Cut back on government spending decrease its impact on aggregate demand • Lowering taxes budget deficit has already been relieved through higher taxes implemented after recession • Decreasing business taxes increase aggregate demand • Increasing interest rates slow down economy to ease inflation

Cut back on government spending Fiscal policy to decrease government spending: (short-term) • Decrease aggregate demand in the short run • Reduce budget deficit in order to create budget surplus • Shift down AD-AS equilibrium to decrease equilibrium price and quantity to a healthy state • Prevent high inflation rate

Cut back on government spending • Short run effect? • Decrease aggregate demand • Long run effect? • Create budget surplus from money saved • Prevent too high of an inflation rate • Keep equilibrium price at a level that does not negatively affect the economy

Cut back on government spending

Decrease income taxes • No more budget deficit • Increase household disposable income • Increase consumer spending • Increased consumer spending will make up for the decreased government spending • We will still see an increase in tax revenue to generate budget surplus

Decrease income taxes • Short run effect? • Increase disposable income drive up consumer demand which accounts for most of the total demand • Long run effect? • Natural economic growth • Now that government spending will decrease this will allow the economy to naturally continue to stay stable

Decrease income taxes

Decrease business taxes • Increase aggregate demand and business investment spending • By increasing firm investments, it will make up for the decreased government spending

Decrease business taxes • Short run effect? • Increase business investment increase aggregate demand by decreasing labor supply curve • Equilibrium price will be lower • Long run effect? • Continue increase in economic growth • Decrease unemployment demand for labor will increase as aggregate demand increases • Control inflation rate so that prices do not increase drastically

Decrease business taxes

Increase interest rates • Means to control the effect of business in the economy • Allows us (i.e. the government) to slow down economy to ease inflation • Goal: to reduce spending by making it harder and less desirable to acquire loans

Increase interest rates • Long run effect? • During high-growth periods this will attempt to slow down the economy • Aids in controlling inflation rate as spending will be reduced due to it being more expensive for individuals to obtain loans • Will prevent another housing boom keep real estate prices at a sensible level

Increase interest rates

Goal? To maintain a certain output (i.e. GDP) that is affected by: • Job growth • Optimal inflation rate • Overall economic growth.

Growing Together