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What To Expect During the Recovery

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					    2009 Chicago Booth
     Business Forecast

            Erik Hurst
V. Duane Rath Professor of Economics
   Neubauer Family Faculty Fellow
       University of Chicago
      Booth School of Business
           A Brief Word on Residential Housing

•   Last Year’s “Take It To The Bank Prediction”

Prediction:   House Prices Will Fall 10 percent over this year.
           A Brief Word on Residential Housing

•   Last Year’s “Take It To The Bank Prediction”

Prediction:   House Prices Will Fall 10 percent over this year.
Actual:       House Prices Fell by 10 percent since last year.
           A Brief Word on Residential Housing

•   Last Year’s “Take It To The Bank Prediction”

Prediction:    House Prices Will Fall 10 percent over this year.
Actual:        House Prices Fell by 10 percent since last year.

•   Prediction was fairly accurate.

•   Predictions based on projections using historical housing price
    booms and busts (using country, state, and city levels).
           A Brief Word on Residential Housing

•   Last year’s prediction:

    House prices will start to stabilize in nominal terms by
    2009Q4/2010 Q1.

•   Update of prediction:

    I am keeping with that prediction. I think we hit the bottom of
    nominal residential house price declines.

    Forecast: Real house price changes will remain sluggish (even
              negative) during the next 3-4 years.
Economic Uncertainty and
   Economic Activity
                 Aggregate Economic Activity



Production   =       Aggregate Expenditure

             =       Consumption +
                     Business Investment +
                     Government Spending +
                     Net Exports
Historical Data
Unemployment Rate: 1969M1-2009M10
            Uncertainty and Economic Activity

Effect of uncertainty on economic activity:

•   Consumers – Delay spending (hold precautionary saving)

•   Firms – Delay investing (hold cash)

•   Banks – Delay lending (hold excess reserves)

Implications:

•   Uncertainty creates an option to wait.
•   Lots of resources waiting to be deployed.
Increases in Economic Uncertainty?
 Uncertainty: Precautionary Savings?
Household Saving Rate (through 10/2009)
 Uncertainty: Precautionary Savings?
Consumer Confidence (through 11/2009)
             Uncertainty:
Excess Bank Reserves? (through 10/2009)
       Where Does the Uncertainty Come From?

•   Health/Loan Portfolios of Banks

       Early on:      Residential Real Estate Portfolios
       Currently:     Commercial Real Estate Portfolios

•   Effectiveness of Past Government Policies

       How big are “fiscal multipliers”?
       When will the stimulus hit the real economy?

•   Uncertainty over Short/Medium Run Government Policies

       What type of regulations/tax policy will be put in place?
        Reducing Uncertainty: Chicken vs. Egg?

•   How can uncertainty be reduced without better economic news?

•   And can there be better economic news without a reduction in
    uncertainty?

•   Slow process of updating (a wait and see approach).

•   Do a little and see what happens….

•   Results in a slower recovery (as economic uncertainty slowly
    reduces).
What are the Risks Going Forward?
                       Speed of Recovery

•   How fast will idle resources be incorporated into productive
    activities?

    o   When will domestic consumption and investment start
        growing at robust levels?

    o   Depends on how fast uncertainty is reduced?

    o   Is there a more structural transformation taking place (over
        consumers and over invested in the past).
Change in U.S. Consumption Out of Recessions
             (Through 2009Q2)
               Another Recession? (“W”-recovery)

•   Related to the uncertainty comment.

•   The economy is still very fragile. Small negative shocks can
    have large negative effects on production when uncertainty is
    looking to recover (signal extraction problem).

•   Results:     Small shocks can cause economy to slip back into a
                 recession.

•   Lessons from 1937!
Central Bank Independence
       Why Should Central Banks Be Independent?

•   Policy makers make trade offs between “unemployment” and
    “inflation”.

•   Labor market clears in the long run and unemployment “corrects”
    itself.

•   Inflation does not correct itself in the long run (without policy action).

•   Reducing unemployment (below its “natural” rate) may have short
    term gains but come with long term costs (inflation).

    Politicians tend to focus on the short run (think President Bush
    during the 1990 recession)
Data: Alesina and Summers 1993
     (Data from 1955-1988)
                   Limiting Fed Autonomy



•   Need to consider the counterfactual – what would happen in a
    world where the Fed is subject to budgetary oversight from
    Congress/President.

•   What is the goal of restricting autonomy?

•   Need to acknowledge the costs.

•   Does this mean the Fed should have no regulations? - No
Some Take Aways
                        Some Take Aways



•   Residential real estate prices are nearing bottom (if not already
    there).

•   Recovery in domestic consumption and business investment
    may be sluggish (despite recession being over).

•   Fed independence is vital for managing inflation rates in the
    long run.

				
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posted:9/20/2011
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