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Subprime Crisis: Much Ado About Nothing


Subprime 'Crisis': Much Ado. About Nothing. Edward C. Prescott. June 5, 2008 ... Burns and Mitchell (1945) developed an empirical definition of business cycles. ... – PowerPoint PPT presentation

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Title: Subprime Crisis: Much Ado About Nothing

Subprime Crisis Much Ado About Nothing
  • Edward C. Prescott
  • June 5, 2008
  • Central and Southeastern Europe Financial
  • Bucharest, Romania

Is There a Major Financial Crisis in U.S.?
  • Overbuilding in the residential section has
    slowed growth
  • Subprime mortgages benefited many
  • Big increase in homeownership
  • Low-cost housing services for many
  • Owners of financial corporations and homeowners
    suffered capital losses after earning big capital
  • These losses small relative to those in 2000-2001

What Happened to Household Net Worth?

Household Net Worth Relative to Gross National

Some Comments
  • Recent decline tiny relative to 2000-2001 fall
  • Current household net worth level is very high
  • Americans do save
  • The savings is under-measured by national
  • Most is in the form of capital gains
  • People start and grow business
  • Corporations make big intangible investments
    which are expensed RD, building organizations,
    developing brands, etc.

Bear Stearns vs. Savings and Loan Crisis
  • Even if the Fed loses all of its 30 billion,
    this will be small relative to the cost of the
    savings and loan crisis
  • 30 billion is about 0.6 of GDP
  • What was the savings and loan crisis?
  • Also due to borrowing short and lending long
  • Tax cost was 124 billion, about 2 of GDP

How Big Was the SL Economic Loss?
  • If lump-sum taxation, loss would be zero
  • But U.S. tax system is not lump-sum
  • So deadweight loss of the SL bailout
  • Losses were about 2 of GDP
  • Huge relative to any conceivable loss from the
    current financial crisis

Benefits from the Savings and Loan Crisis?
  • For one, though it may have played a part in the
    crisis, deregulation of the financial sector in
    the early 1980s has greatly enhanced the
    efficiency of credit markets
  • Households earned more on their lending
  • Households paid less on their borrowing

Is the U.S. in a Recession?
  • Burns and Mitchell (1945) developed an empirical
    definition of business cycles.
  • They represented the economy by periods of
    expansion followed by periods of contraction
  • We now have a theory of business cycles.
  • Kydland and Prescott (1982) won the Nobel Prize
    for initiating the development of this theory.

New Definition of Business Cycles
  • Correct for working-age population size
  • Correct for 2 trend productivity growth
  • Trend growth about 3 in the U.S.
  • The NBER procedure not scientific
  • Implicitly uses 0 trend growth
  • Recessions often disappear with the revised

(No Transcript)
U.S. Detrended GDP per Person 16-64
Is the U.S. in a Recession?
  • The answer is NO
  • Low growth persisting for another TWO years for a
    small recession

Will U.S. Enter a Recession Soon?
  • Answer No
  • Not unless
  • Tax rates are increased or
  • U.S. shifts to an anti-globalization policy
  • U.S. shifts to an anti-productivity policy

Tax Rates and Hours
Advice for Romania (and the U.S.)
  • Worry about productivity
  • Become more open
  • Continue investing in nuclear energy
  • Train technical people for high-tech jobs
  • Dont increase tax rates

The Future
  • I am optimistic about the economic future of both
    Romania and the U.S.
  • Romania is in the EU. It is only a matter of time
    before it catches up to the EU-15 and the U.S.
  • Thank you for your attention.