A Students Guide to the Current Economic Crisis

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A Students Guide to the Current Economic Crisis

• Dave Colander
• Middlebury College

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Outline of Talk

• Provide a bit of history of macroeconomics
• Discuss how the AS/AD model can be used to
  explain the current crisis
• Discuss why the crisis is scary and the
  governments attempt to get us out of the crisis.

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The Macro Economy as a complex system
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Some Macro History

• Macroeconomics as a course developed in the 1930s
• Before then, the was Classical economics, and
  quantity theory of money
• Macroeconomics became associated with Keynesian
  economics and a specific limited interpretation
  of Keynesian economics
• Keynesian economic theory was soon sidetracked
  into simple equilibrium models that didnt
  capture possible dynamic instability.

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Explaining the current crisis in words

• Structural economy changed in 1990sinflation
  ended due to global competition
• Government expanded money supply private sector
  expanded leverage.
• Bubbles in asset markets were created by leverage
  and expectations.
• Not noticed because there was no goods market
  inflation
• Nominal wealth increased more than real wealth
  could. People had irrational exuberance and
  expectations.

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Causes of the Current Crisis

• Too Easy Monetary Policy
• Too Easy regulation
• Too strong reliance on models and past history

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Explaining the Current Crisis in the AS/AD Model

• The Use and Abuse of the AS/AD model The one
  thing at a time approach
• Whats being held constant?
• Standard Story is an equilibrium story
• Whats missing? Dynamic disequilibrium problems

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The Dynamic Disequilibrium Story When Other
Things Dont Remain Constant
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Explaining the Current crisis in a Picture

• A 450 pound 5 ft 10 inch man has a heart
  attack.

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Explaining the Current Crisis in the Quantity
Theory

• MV PY
• Global competition changed the connection asset
  price bubble
• Failure to distinguish between real wealth and
  nominal wealth
• Money no longer the relevant issuethe quantity
  theory of credit.

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Government Response to the Crisis

• Triage Policy
• Treatment Policy
• Rehabilitation

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Triage Policy

• Why is the financial sector different. It is the
  economic equivalent to the heart.
• If the financial sector stops beating, the
  economy stops.
• The Troubled Asset Rescue Package (TARP)the 700
  billion triage policy. Keep the financial sector
  going.

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Treatment policy

• Monetary policy
• Liquidity trap
• Quantitative easing
• Fiscal policy
• Fiscal stimulus
• Automatic stabilizers
• Expectations policy

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Rehabilitation Stage

• Repairing the Damage Done in the Triage and
  Treatment Stage
• Eliminating the Deficit
• Creating a sense of fairness
• Countering the sense of unfairness from the
  bailout programs.
• Too big to fail and the moral hazard problem
• The Problem waiting in the Wings International
  Financial Crisis
• Trade deficit
• Dollar overhang

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Three Ideas to Keep in Mind in Structuring new
Regulation

• The golden rule of economics Him who has the
  money makes the rules.
• If you will bail out, you have to regulate avoid
  the moral hazard problem
• Law of Diminishing Regulation Technological
  change and leaning by sneaking around undermines
  regulation