Econ 144 Unit 4 Notes
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Date Created: 02/09/15
Econ 144 Unit 4 11052014 Lecture 2 110514 Securitization take a bunch of loans and bundle them together and sell them like a bond to an investor The payments were coming from people paying their mortgages Mortgage Back Security MBS Asses Backed Security ABS and CD0 Credit Default Swap CDS Insurance for an MBS in case it goes bad o If you thought the mortgages would never default you loved selling a CDS If you thought the mortgages would default you were buying the CDS in hopes of them failing It all turned into a bet and people were betting on the bonds who didn t own the actual bond Someone else betting on my house burning down MBS s were limited by the mortgages but the CDS s were unlimited at one point in time the CDS s were so numerous they would ve totaled 60 trillion dollars more than the world s GDP at the time in 2007 0 People who sold the CDS s never required to demonstrate that they actually had the funds to pay the insurance 3 levels of risk 1 Initial mortgages themselves which eventually went bad 2 The MBS s based on the mortgages which eventually went bad 3 The CDS s the insurance which eventually had to be paid out a Thousands of houses and condos were built to meet the increasing demand which ooded the housing market which made house prices start to fall interest rates rose and people start to default on their mortgages in large numbers more than anyone expected b Promises to pay insurance if loans go bad because nobody ever had to prove they had the funds to pay the insurance and they didn t have the money to pay out the insurance c Big investment banks on wall street bought CDS s and CDO s and they also held them on their own balance sheets as investments 0 No banks knew the value of these investments and no bank knew what the other banks were worth 0 Therefore everyone stopped doing business with everyone else The Role of Credit 0 Business all operate on credit Employees have to be paid weekly supplies needed daily but clients often only pay their bill quarterly During the in between companies maintain loans of lines of credit with banks to keep operating lf credit dries up all business stops even healthy businesses Bernanke and the Fed Bernanke is an expert on the Great Depression and he knew that banks stopping to lend money was disastrous Bernanke and henry Paulson felt they had to do whatever necessary to free up the credit markets So they arranged to buy these CDS s and CDO s and MBS s toxic assets off of the books of the big banks Troubled Asset Relief Program TARP aka the Bailout Pg 883 TARP Troubled Asset Relief Program Allows the Treasury and the Fed to purchase toxic assets from the large banks lntent was to get them to start making loans against and to unstop the credit markets Up to 700 Billion Monetary policy When the price of a bond goes up the rate it pays goes down When the price of a bond goes down the rate it pays goes up Interest Rates whether paying or receiving tend to go updown together If the rate people are receiving on bonds goes down the rate people pay on things carshouses should go down too So somehow increasing the price of bonds should lower interest rates people pay on things like car loans house loans How could the Fed increase the price of bonds By buying a bunch of them Demand for anything increases the price goes up The Fed was doing this to lower interest rates not increase the money supply Quantitative Easing Operation Twist 1 Fed sells a bunch of shortterm bonds Selling bonds lowers their prices raising rates Uses that money to buy longer term bonds Buying bonds increases their prices lowering longterm rates Long term interest rates go down mortgages cars 0 6 Should get cheaper to get mortgage or take out a business loan 0 By selling short term bonds at the same time as buying long term bonds Fed does not increase the money supply but lowers interest rates at the same time o It was a great success in the US and in the UK 0 U39IlgtUUI Chapter 27 Fiscal Policy and the Government Fiscal Policy Taxes or Government Spending Use of government spending and taxes to adjust aggregate demand C is affected by taxes Automatic Stabilizers 0 Not scal policy 0 Government spending and taxes that automatically change with the business cycle 0 Times are good tax revenues increase 0 Times are bad government spends more on unemployment Fiscal policy is outside the normal course of business An Overview of Government Revenues Income taxes biggest part Corporate taxes Social Security Excise Taxes 0 Five years ago corporate taxes made up 145 of the government s revenues Government s Expenditures Transfer Payments biggest part social security Medicare and Medicaid Defense Interest on the Debt Grants to localstate governments and other Department of Education Justice Energy Agriculture Labor Commerce etc American Recovery and Reinvestment Act of 2009 aka Stimulus Bill Signed into law by President Obama 0 quotthe most sweeping economic recovery package in our historyquot Fiscal Policy Changing Government Spending or Taxes 0 Taxes affect Consumption pg 894 Automatic Stabilizers are not Fiscal Policy 0 Government spending and taxes that automatically increase or decrease with the business cycle American Recovery and Reinvestment Act of 2009 aka Stimulus Bill 0 Speci cally done to put money in people s pockets so that they would spend their money 0 This was designed to push AD to the right 0 Not the Bailout Different time period and different goals 0 825 Billion in Stimulus o 63 of that was for Government Spending 0 Money for all of these projects is still being paid out Kansas is still owed 600 million out of 26 B n 6000 jobs created Missouri is owed 300 million out of 49 B a 15000 jobs created California got 31 billion New York and Texas got 17 billion 0 37 of the Stimulus was for Tax Adjustments 237 billion in tax cuts for individuals 51 billion in tax cuts for businesses 0 Did the Stimulus Bill work Pg 912 0 Six of nine articles posted in the Washington Post say that it did work one says it worked a little and the other two say it didn t work at all 0 GDP would ve shrunk an additional 15 without the stimulus 0 Two million jobs would not have been created without the stimulus 0 Overall the stimulus worked for the most part main objective was to make the recession ess bad and it did this Some economists have estimated that the multiplier is approximately 2 to 3 and others say that the multiplier is actually less than 1 Pg 914 How can a multiplier be less than 1 Crowding Out pg 908 o The claim that government spending reduces private spending 0 If the government spends a dollar that s a dollar that I don t have to spend and that companies don t have to spend Crowding Out in Three Steps 0 1 Government Spending Increases Interest Rates 0 2 Consumption and investment are lower than they would be 0 3 G might go up but if it raises interest rates then C and go down and this undoes much of the good making the multiplier less than 1 At the same time the Fed was making sure that interest rates remained low suggesting that crowding out is not happening right now Tax Multiplier pg 905 0 Reduction in taxes also ripples through the economy 0 Also based on what we spend MPC Tax cuts give a smaller ripple effect Ripple effect is limited to what is actually spent by people instead of the entire tax cut mainly because we don t spend every dollar we earn 0 Assume MPC is 75 Taxes cut by 100 Billion but spending only increases by 75 B o 1175 475 billion Output increases by 300 billion 0 Tax Multiplier Changes in Real GDP Changes in Taxes pg 905 0 Tax Multiplier MPC1MPC pg 932 0 Give you same number both end up smaller than the government spending How did we pay for the Stimulus Bill The de cit in any single year federal government takes in and spends 0 When we spend more than we take we run a de cit A deficit is a oneyear thing 2014 de cit expected to be 514 billion Our de cits have never been as large as they were in 20092013 We are currently still paying for the Stimulus Bill The Debt is all of the de cits added up and the total is the debt 0 We ve been in debt every year for the USA except for 1835 0 Currently 179 Trillion highest our debt has ever been nominally Debt for a country can be like debt for a company 0 Big corporations take on debt all the time 0 Debt can be a very useful way to nance new project or for new products o If you can borrow at 3 and it increases your income 8 it s smart to take on the debt Debt ceiling congressional limit on how much debt we as a country canissue It s been around since 1917 and we ve increased the debt ceiling 33 times in the past 40 years 0 1 Running a de cit reduces Investment 0 2 Companies quotundertaking investmentquot Running a De cit slows down our growth by reducing access to capital 0 Also increases interest rates pushing AD to the left and continually restricting growth Connect the Dots o 1 Increasing the debt ceiling allows the government to run a de cit and borrow more 0 2 This shifts the supply of loanable funds back to the left 0 3 This reduces investment and investment is what makes an economy grow Shifts AD to the Left 0 4 This also increases interest rates Econ 144 November 12 2014 III 4th Lecture After 3rCI Exam Still on Fiscal Policy National Debt 179 Trillion Dollars United States Savings Bond that is a debt Who do we owe Split it into ve big groups 0 1 Portion that one part of the federal government owes another part of the federal government 14 2 Portion that the federal government owes people like me 30 3 Portion that the federal government owes to other countries35 4 Portion the federal government owes the Federal Reserve 15 5 Portion of the Federal debt we owe to state and local government 6 2 About 30 of the debt is owed to people like me US Households State Local Federal Retirement Funds Private Pension Funds Money Market Mutual Funds Commercial Banks Other Mutual Funds 1 Portion that one part of the government owes another part of the federal government 0 You have social security withheld from your paycheck In the past we ve taken in more than we ve paid outThat excess is called the trust fundThe trust fund doesn t sit there as dollars rather it is invested in government bonds This is about 15 0 Federal Reserve currently owns about 14 of the Debt Portion we owe to statelocal governments 6 0 So we owe about 65 to OURSELVES We owe other countries approximately 35 of the 179 Trillion to other countries 0 China gt 12 Trillion 0 Japan gt 12 Trillion 0 Belgium gt 365 Billion These gures are in DOLLARS not YEN OR ANYTHING ELSE We can print Dollars Debt to GDP Ratio Our debt 179 Trillion Our GDP 175 Trillion Our debt to GDP ratio 102 Post WWII was the highest it s ever been at 120 To reduce the debt 0 Government must actually eliminate the de cit and run a surplus Only 4 surpluses in over 40 years To reduce debttoGDP Government must reduce yearly de cit If GDP grows at 3 but debt only grows by 2 then DebttoGDP lower Two Harvard economists Published a paper that said when a country s debttoGDP ratio passes 90 economic growth slows down quotSEQUESTER AUSTERITYquot Then Thomas Herndon at University of Massachusetts reproduced The Harvard grads left out 5 of 20 countries and they used the wrong kind of averaging without correct weights In 1980 Regan policy supply side economics page 922 Tax Wedge Difference between pretax and posttax return to any activity Supply Side Economics 0 Cutting taxes on any activity will increase the level of that activity 0 Cutting taxes on consumption will increase consumption tax free weekends 0 Cutting taxes on investment will increase investment 0 Cutting taxes on income will increase the amount of labor suppliedwhich increases output GDP The discretion with the income is some people work and are paid hourly and others are paid on some sort of salary Therefore taxes don t necessarily control the hours In book they have Individual income tax cuts will 0 Increase the quantity of labor supplied 0 Increase opening of new business 0 Increase Savings since savings income interest would be taxed less They also have corporate income tax cuts Next Class Cutting taxes on income will increase the amount of labor supplied which increases output GDP LRAS moves to the rightwhat we can produce The question is do we have a shortage of labor supply or do we have a shortage of labor demand Test 4 Info Need to Know 0 Chapters 26 and 27 from the book on the test 0 Money Market 0 Taylor Rule 0 Financial Meltdown and Fed Policy 0 Quantitative Easing o HscalPoHcy 0 Government Expenditures and Revenues o The Stimulus ARRA Crowding Out Multipliers Debt and De cits and Debt to GDP 0 2 Multipliers Government and Tax Important 0 Government 11MPC bigger number 0 Tax MPC1MPC smaller number Tax cut makes less of a ripple than G Chapter 27 Supply Side Economics pg 920 Tax wedge difference between pretax and posttax return to any activity Supply Side Economics 0 Cutting taxes on any activity will increase the level of that activity 0 Consumption Investment and Income Individual Income Tax Cuts pg 920 Increases quantity of labor supplied Increases Openings of New Businesses Increases Savings Income would be taxed less Corporate Income Tax Cuts Would encourage investment spending 0 By increasing pro ts that corporations make when they invest in new equipment 0 Might spur innovations and technological advances Increased labor and capital shift LRAS to the right 0 Output would go up and prices would go down Just because we can produce more doesn t mean we will produce more and doesn t mean we will demand more 0 Will incentive to supply more labor actually result in increased labor Demand may not be there for additional labor Tying this to the Debt Issue 0 If we lower taxes and nothing else changes 0 De cit will get larger 0 Debt will get larger 0 Lower taxes increases GDP 0 GDP is our income 0 Lower taxes on higher income can theoretically produce higher tax revenue quotTax cuts pay for themselvesquot BULLSHIT You end up paying less taxes than the actual tax bracket you are in o If you make 100000 you don t pay full 28 You end up paying 21000 not 28000 Does Cutting taxes increase the incentive to earn o It can but only if the difference in tax rates is signi cant Does an Increased incentive to earn lead to higher GDP and higher GDP growth 0 Not necessarily and not always Salaried Employees are unaffected
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