how can spain and the u.s. recover from their depressions edward c. prescott
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How Can Spain and the U.S. Recover from their Depressions
Edward C. Prescott
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U.S. Long-Run Picture
Relatively steady growth over the last 150 years
Some fluctuations about trend (HP filtered)
Source of following pictures is Robert E. Lucas, Jr.
3
4
Deviations From Trend
Relative to trend, GDP lost 40% between 1929 and 1933
Recently the loss has been about 8%, and this has occurred over the last 14 months
5
Stock of Intangible Capital is Huge
It is as big as the stock of tangible capital– Tangible capital is about 3.8 times GDP, which is
measured output– This is $190,000 for every man, woman, and child
Tangible capital includes– Houses, factories, vehicles, roads, office buildings,
retail stores, some software, computers, etc
Reason for Depression Was Not the Financial Crisis
Except through policies it led U.S. to adopt
Depressed U.S. economy depressed rest of world
China, India, and Brazil have already resumed healthy growth
Europe, with exception of some Mediterranean countries, will soon
What Are the Roles of Financial System?
Saving for retirement
Financing capital– In the US of the 3.4 GDPs of private capital
• half equity (owner) financed• half financed by debt• this is the case for real estate, which is the biggest
component of capital
Total Household Borrowing Equals Total Household Lending
Lenders are people saving for retirement
Borrowers are people who own businesses with debt– This debt is the debt of the owners– Household businesses have big debt– Unincorporated businesses have big debt– Corporate businesses have big debt
Parallels Between Current and the Great Depression
Both started with collapse of a real estate boom
Both started with the near complete cut off of immigration
Both times, stimulus plans were instituted with large increases in spending and taxes
Both times, there was a shift to anti-trade policies
Both times, the White House started managing the economy
The Reason that the US Economy had a Great Depression in the 1930s and is Currently Depressed is
NOT the Financial Crisis
No financial crisis until U.S. was well into the Great Depression
And then it was a small crisis
Businesses had funds to make profitable investments
Businesses had huge cash flows
They paid big dividends rather than financing investments with retained earnings
This implies a lack of perceived profitable investments
Reason for Not so Great Current Depressionis the Same
Businesses have funds or access to borrowing to make profitable investments
Currently U.S. banks are lending huge amounts to the Federal Reserve Banks
This lending is at a low rate
– 0.25% nominal– negative real
Problem: Banks do not have good lending opportunities
Current US Depression
Politicians are trying to foster more construction even though there is an excess supply of houses.
One way to stimulate the depressed construction industry is to destroy half the housing stock– If done, there would be a construction boom– This would be bad policy
U.S. Should Ban Institutions that Borrow from One Group and Lend to Another and
are Highly Leveraged
Such as Long Term Capital Management, Bear Stern, Lehman Brothers
Mutual lending organizations are good– People lend and bear the risk of bad loans– Institutions like Caja Navarra should be encouraged– Mutual pension funds should be encouraged– Mutual bond funds should be encouraged
Reserve requirements for commercial banking should be high and government insured deposits minimal
What Depressed the Economy today and in the 1930s?
Not market failure
Rather failure of the central government
If people expect higher tax rates on distributions from their businesses in the future, they rationally– cut investments now and– increase current distributions
What Will Make the Economy Boom
Cut marginal tax rates
– People will work more
– Businesses will invest more
– Output and personal consumption will increase
Be open
Do not erect barriers to the use of better production processes
Another Way: Pray for Another Technology Boom
The economy will boom if there are abnormally large increase in the technology level as happened in the first half of the 1960s and last half of the 1990s
– Politicians should not pander to special interest groups with vested interest in currently use inferior technologies of production
– If they do, there will be no boom as barriers to using the new superior technologies will be erected
Cutting Government Expenditures Will Help
The increased expenditures in World War II increased employment and output
But it reduced welfare as household consumption and leisure fell – just as theory predicts
Governments should make investments only if the benefits exceed the costs – If benefits exceed costs, they stimulate the economy– If not, they depress the economy
Increasing Marginal Tax Rates will Not Increase tax Revenue
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GDP and Tax Revenue per Person
00.20.40.60.8
11.21.41.6
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Tax Rate, t
GDP
Tax Revenue
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Welfare
Because of taxes, the value of time on margin
used in market sector is twice that used in
nonmarket sector (If tax rate 50%)
Nonmarket time is valuable
Welfare gains in lifetime consumption
equivalents per year are …
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Welfare Gains and Losses
-20%
-10%
0%
10%
0 0.1 0.2 0.3 0.4 0.5 0.6
Current U.S.
Europe
Tax Rate
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Macro Theory Works
Given productivity, population, and taxes:
– Predicted and actual paths of the aggregate variables coincide
– All using dynamic economic theory to construct models consistent with national account and other data find same thing
– All find monetary policy has and had little real consequence
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Then What Depressed the U.S. Economy
Fact: Investment suddenly became depressed in the last third of 2008 – there was a regime change
There are 25 million small businesses in the U.S. and 5 million of them have employees
Their owners feared higher tax rates with the regime change and they
– Rationally cut investment
– Rationally cut employment
– Took more cash out of business
Workers fearing job loss rationally cut auto buying
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Fears Are Being Realized
Tax rates are being increased
These increases lower amount of capital a firm chooses to have
Reason for low investment is not problem of getting loans – it is expected future high tax rates
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Liabilities of Households and of Nonfinancial Businesses They Own
End 2007 End 2008
Total Liabilities (billions $) 31,875 32,341
Composition Share
Mortgages 44.9% 44.4%
Other Loans 18.0% 18.5%
Corporate Bonds 11.2% 12.0%
Security credit 1.0% 0.5%
Trade payable 8.2% 8.5%
Other 16.8% 16.1%
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Cost of Current Crisis
Huge bailout of lenders to financial intermediaries by taxpayers
This means higher tax rates in future and a depressed economy now
The ‘stimulus’ plan is a depressant plan
To argue spending stimulates the economy is equivalent to arguing cigarettes are good for your health or CO2 is not a greenhouse gas
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Evidence that Low Marginal Tax Rates Boost an Economy
This uses the simple methodology developed in my American Economic Association 2002 Ely Lecture
Factors other than the marginal tax rate matter, so fit not perfect
Also errors in measuring hours worked
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Predicted vs. Actual Weekly Hours
GermanyFranceItaly
Canada
U.K.
Japan
U.S.Spain
IrelandIcelandNew Zeland
Australia
Denmark
Portugal Romania
16.0
18.0
20.0
22.0
24.0
26.0
28.0
30.0
16.0 18.0 20.0 22.0 24.0 26.0 28.0 30.0
actual
predicted
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Effective Measures Against the Depression in U.S. Economy
Cut marginal tax rates
Become more open
Follow pro-productivity policies
Reform labor market policies so workers move quickly from where they are less productive to where they are more productive