Growing TogetherVanessa Rodriguez

OverviewThe 5 W’s of the Great Recession

The Who, What, Where, When, and WhyResponse solutions to the crisisPrevention policies to avoid a relapse

How do we prevent another recession?

1. Figure out where things went wrong

2. Learn from our mistakes

IN EVERYMISTAKE

THERE IS A POTENTIAL

FOR GROWTH

WHO contributed to the development of the recession?1. Oil Shock

Oil prices skyrocketed from ~$75 to ~$146 per barrel from 2007 to 2008

WHO contributed to the development of the recession?2. 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?3. Worldwide Financial Market Crisis

Subprime mortgage crisisLehman Brothers investment bank failure

WHAT were the consequences?1. Increase in oil and food prices

Led to consumer spending of other products to decrease

C GDPGDP = C + I + G + NX

WHAT were the consequences?2. Subprime mortgage crisis led to an even further

decrease in consumer spending as well as a decrease in business investments

I + C GDPGDP = C + I + G + NX

WHAT were the consequences?3. Lehman Brothers investment bank failure led to

a global banking panic

GDP = C + I + G + NX

C + I + NX GDP

WHAT were the consequences?

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 recessionSource: 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 2010Source: 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 DepressionFrom this date until 2007 many problems began to

arise:1. Banking deregulation2. Household saving rates decreased3. 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 necessaryMonetary policy was thought to prevent another

recessionPolicy reappraisal led to a healthy economy no

signs of threat to the future economy were apparentOil & 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 crisisGovernments gave financial support to their banks

FAILED to stimulate consumer & business spending temporary relief to banks

Governments implemented fiscal policiesSUCCESS in the long run stimulated demand even

though it increased public debt (i.e. government spending)

Monetary policies by major central banksFAILED in the short run did not ease the credit crisis

How do we prevent another recession?1) Unemployment rate low (i.e. full

employment)2) Low inflation (i.e. optimal inflation target)3) Economic growth

Keep AD constantControl:Consumer spendingBusiness investmentsExports

Generate budget surplusCut back on government spending decrease its

impact on aggregate demandLowering 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 spendingFiscal 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 spendingShort run effect?

Decrease aggregate demandLong run effect?

Create budget surplus from money savedPrevent 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 taxesNo more budget deficitIncrease 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 taxesShort 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 taxesIncrease aggregate demand and business

investment spendingBy increasing firm investments, it will make up for

the decreased government spending

Decrease business taxesShort 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 growthDecrease unemployment demand for labor will

increase as aggregate demand increasesControl inflation rate so that prices do not increase

drastically

Decrease business taxes

Increase interest ratesMeans to control the effect of business in the

economyAllows us (i.e. the government) to slow down

economy to ease inflationGoal: to reduce spending by making it harder and

less desirable to acquire loans

Increase interest ratesLong 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:1. Job growth2. Optimal inflation rate3. Overall economic growth.