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2013-11-18 The Great Depression and the Great Recession.docx

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Political Science
Political Science 2211E
Adam Harmes

The Great Depression and the Great Recession November 18, 2013 Today’s Topics 1. Causes and Types of Recessions 2. The Great Depression 3. The Great Recession 4. The Neoliberal-KW Debate Over the Great Recession 3 types of recessions 1.Business cycle recession Business Cycle Recessions -Central banks maintain a balance between inflation and unemployment -Recession can occur when central bank raises interest rates to fight inflation -Central banks control interest rates; maintain balance between inflation and unemployment -business cycle either speeds up or slows down depending on whether interest rates are raised or lowered -lower interest rates = means you pay less for your loans = stimulate economy = people spend more = companies sell more = companies hire more employees = unemployment rates go down -high demand on goods and services = companies increase price = creates inflation = central banks slow down economy by reducing demand by raising interest rates -central banks are better at targeting interest rates to avoid overshooting -wants to avoid overshoot -trying to reduce demand, but sometimes inflation is high that you need recession to slow inflation down and bring it down -Central Bank causes it Oil Shock Recessions -War, weather, etc causes sharp rise in oil prices -Oil prices lead to inflation -oil: our primary form of energy -when oil prices go up, companies have to incorporate that price increase to their products -basic cost of business -globalization: many products are shipped overseas; requires oil because of different modes of transportation (e.g. car, sea, place, etc.) -Central bank raises interest rates to fight inflation -global price of oil spikes up sharply -this is due to war, hurricane, etc. that disrupts supply of oil 1 -all of a sudden, you have a war in Middle East -e.g. fuel surcharge applied Asset Bubble Recession -A.k.a. ‘balance sheet recession’ -Involve high levels of private debt -Start with bursting of an asset bubble -involve high level of private sector debt and generally starts with the busting of an asset bubble -asset bubble can be: stocks, currencies, houses -Prices rise far above fundamentals -Fundamentals = real economic conditions that affect the value of that asset -Conditions include the performance of the company (e.g. sales) -Occurs when people borrow money to speculate -Rising assets used as collateral -e.g. housing bubble: the price of houses are skyrocketing because there’s a high demand -speculative investment: more people are borrowing money and invest in houses -creates feedback effect -stocks can be used as collateral -market will correct; price will fall down dramatically and quickly Bubble Bursts, Crisis Begins -Prices crash -Those who borrowed to speculate default on loans -Some banks fail and this causes panic and bank runs -people can’t pay back their loans -banks who made these loans have to write off these loans -banks have to take these defaulted loans -some banks will ultimately start to rf -when a bank fails: people start to take money out during bank run Bank Runs and Credit Crisis -Collapse of one bans creates domino effect and more collapses -Depositors panic and ask for money back -collapse of one bank (or even rumours) can create domino effect -collapse of one bank causes worry amongst people that their own bank will fail -Bank has to sell assets at panic prices and goes bust -this creates a self-fulfilling prophecy -people think the banks will end...... 2 -Banks stop lending -don’t loan money to other banks, consumers/people, corporations -leads to a drop in spending and demand Asset Bubble Recession -leads to a vicious cycle of -Financial crisis and no lending creates vicious cycle of: 1. falling confidence 2. Less spending 3. bankruptcies, layoffs, and unemployment Falling consumer and business confidenceless spendingbankruptcies and unemployment -cycle -it’s not just question of confidence The Great Depression -a normal recession became the Great Depression The Mundell-Fleming Thesis Capital Mobility | ____________|__________________ | | | | Fixed Exchange Rate -----------------------Discretion in Monetary Policy -government can only pursue only two of them at same time -capital is mobility: can move money -Fixed Exchange Rate: set a benchmark -use interest rates or have money abroad: always keep value of currency within that set fixed exchange rate products to the exchange rate..? -Discretion and Monetary policy: ability to raise and lower interest rates 3 -lowered to combat recession -government use 2 of these three; not all three -if government have capital mobility and fixed exchange rate -give up discretion in monetary policy: it has to use interest rates when value of currency….? -keep currency at set - -lower interest rates to stimulate out of recession, but if they do it, money will leave country and currency fall out of that exchange rate -you give up fixed exchange rate once you lower interest rates -before Great Depression, there was only fixed exchange rate and capital mobility (no discretion monetary policy) -had free-market globalization -globalization: free market policy on trade and finance -but removed it after Great Depression….? World Economy Before Depression 1. Capital mobility + free trade = economic globalization 2. Gold Standard fixed exchange rates o CurrencyAcan set price relation to the price of gold o Currency B and C would do it o The currencies would all move at the same time 3. No discretion in monetary policy o No ability to stimulate economy and lower interest rates o *before Keynesian economics 4. Limited democracy and trade union = little focus on unemployment o Democracy limited in number of countries back then o Limited in having political parties representing interests of working class o E.g. Britain’s Labour Party, Canada’s NDP, etc. o Trade unions limited o Workers had limited political influence and power 5. Limited welfare staff o Social programs didn’t exist back then o If you were unemployed, you didn’t have employment insurance back then o No regulation back then – if bank went bust, you lose all your money (government didn’t save you) Great Depression -Began as an asset bubble recession -Roaring 20s – massive stock market bubble 4 -Booming economy in the 1920s -Stock market bubble as more borrowed to speculate -Fed raises interest rates to prick bubble -stock prices soaring -more and more people borrow money to invest in stock market -government wanted to slow this down -raise interest rates and try to deflate bubble -sometimes works, sometimes doesn’t -doesn’t want to prick bubble -slow down money flowing in stock market and hopefully have price to settle down -didn’t work 1929 Stock Market Crash -Higher interest rates cause stock market to crash -Financial crisis as banks fail and cause panic -Panic leads to banks runs and credit crisis -October 29, 1929 – Black Tuesday -bursting of bubble cause financial crisis -many investors default on loan -the money they borrowed to invest in stock market are default and can’t meet payments – start to default on those loans -banks start failing -banks have to writeoff loans and some become bankrupt -bank runs: everyone rushing to banks and withdraw money -bank runs: no way to stop it back then -no deposit insurance, no bailouts back then -more banks start failing = more panic = more bank runs = dominoes start falling -banks collapsing leads to credit crisis -stop lending to other people (companies, each other); no money -financial system massively seizing up -Great Depression began as a standard asset bubble recession -failing banks cause recession -falling business and consumer confidence = consumers and businesses stop spending (can’t borrow any money) = creates this vicious cycle of falling business and consumer confidence = companies selling less = layoff workers (unemployment rate goes up) = companies go bankrupt -??????????????? 5 The Collapse of Free Trade -Excess production leads to falling prices -Countries respond with tariffs Smoot-Hawley tariff in US -put tariffs on 20,000 import items; -Free trade collapses and further hurts confidence -problem of free trade was on the agricultural side -excess production: some countries respond by raising tariffs -Smoot-Hawley tariff = countries respond to economic nationalism -take care of our own first -e.g. today’s Obama’s BuyAmerica -countries go “me first” -1930 US Congress passed Smoot-Hawley tariff act -led to trade wars -free trade collapsed and hurt confidence, demand From Recession to Depression -started as a normal asset bubble recession -Became Depression as governments defended fixed exchange rates -Raised, rather than lowered, interest rates -it was a severe normal bubble -it became a Depression when instead of lowering interest rates to stimulate economy, countries raised interest rates -countries are raising interest rates -fundamental problem is monetary policy Government Response -Raised rather than lowered interest rates -countries raise interest rates because they focus on defending their fixed exchange rates -No bank bailouts -No automatic stabilizers -no employment insurance, welfare, etc.-->didn’t exist back then -e.g. you lose your job, you don’t have EI or welfare to help you -Austerity not stimulus -no stimulus programs at the time -Led to massive unemployment and hardship -Unemployment rate was around 25%+ Great Recession -Banks issued sub-prime mortgages 6 -issuing loans to people who shouldn’t be getting mortgages (due to bad credit ratings or not sufficiently good credit ratings) -a.k.a. ninja loans – no income, no jobs, no assets = you can still get a loan -higher risk mortgages issued to people with bad credit ratings; bad = insufficient for the amount they borrow -banks need to make money by issuing more and more mortgages -but if they loan to people with so many bad credit ratings and they don’t pay back loans = banks lose a lot of money -normal market discipline: don’t do that -problem: what caused them to go beyond that and issue them to people with bad credit ratings? -more people have money to buy houses -Banks sold mortgages to investors to raise more money -banks loan money to you; banks get IOU -banks staple IOUs together and sell them to investors and investors buy these mortgages and now those people owe the debt to investors -you get more and more money flowing into housing market from broader financial system -you get more people buying second homes as investment (they don’t need it) -more people buy houses = more demand for houses = prices go up = motivated to buy another house = value goes up and you can sell it -flipping houses -get more
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