耶鲁大学金融市场英文文本Financial-MarketsLecture-26-Transcript.doc

Financial Markets: Lecture 26 Transcript Professor Robert Shiller: This is the second of two lectures from Lawrence Summers. Let me just say, again, this is the Okun Lecture Series created by an anonymous donor in honor of Arthur Okun. At the last lecture, I was very pleased to hear the number of fond memories that Larry Summers has of Arthur Okun. At todays lecture, I think some people felt that we didnt have enough time for question and answer, so we plan to allocate a half hour to that. Does that sound good? Larry will wrap up just before the hour and well have a good discussion. Professor Larry Summers: Judging by the discussions I had an opportunity to have at lunch and dinner, I would suggest a proposal for you, Bob, with respect to next years Okun lecturer. Invite the Okun lecturer to give his first lecture, then let him have dinner and let him have lunch with the Yale faculty; then, let him ponder what hes been told for three weeks and invite him to come back and encourage him to emphasize what he was told rather than any ideas he might have. You would get substantially better Okun lectures, I suspect, as a consequence, if the feedback that I got is any guide. I want to thank everybody for their hospitality and having seen a certain number of these kinds of lecture series over time. When I was President of Harvard, my deepest nightmare, one of my deepest nightmares-some of my nightmares actually came true-but some of my lesser nightmares as President of Harvard were the sequential lecture series, where at the third lecture no one came. As a lecturer, I was concerned the judgment of those who had seen the product is of more interest than the judgment of those who have not. So, the fact that the room looks a little bit like the room looked yesterday, I take as at least mild encouragement and validation to proceed. Yesterday, I talked about two types of recessions. What I referred to as disinflation recessions, in which the Fed stepped on the brakes, the economy slowed, the Feds stepped off the brakes, the economy reaccelerated. And, what was my larger focus, financial system breakdown recessions, in which in one way or another, bubbles burst or banks face liquidity problems or the supply of finance dried up and the economy suffered. I suggested that the latter category of recession was the historical pattern of recession. That there were some signs that the more relevant problem for the United States going forward might well be the latter kind of recession as well. I implied a thought I will develop in the course of these remarks-that the incipient recession in the United States is almost certainly of the latter financial breakdown variety rather than the disinflation variety. We have had instructive, for me, conversations at both dinner and lunch on the question of how one thinks about these two categories of recession in the context of an ISLM model or in the context of a simple-some kind of simple-macroeconomic model. The correct answer to that question, I think, is that its pretty unambiguous that a disinflation recession is best thought of as the Federal Reserve tightening money, which represents some kind of leftward movement of the LM curve-that output declines and interest rates rise and that thats the proximate shock that is bringing about the recession. That it turns out to be a matter of semantic ambiguity-how to think about a financial crisis recession in the context of a simple macroeconomic model. Everybody agrees on the movement of three variables in such a recession. Output goes down; q goes down; and short-term interest rates go down. One instinct, which is probably not the first instinct in the City of New Haven, is to think of that recession in a traditional ISLM curve, with the IS curve and the LM curve being plotted in a space determined by the level of output and the short term interest rate. In that formulation, it is clearly an IS shock. The level of output declines; the level of interest rates decline as well. An alternative formulation and a formulation that is probably more in the spirit of Yale economics is to think of the ISLM diagram as having been drawn in a space that focuses on output and the required return to capital or focuses on output and q. In a formulation of that kind, there hasnt been a shock to the relationship between investment and the price of capital. Theres been a shock to the price of capital at any given level of the short-term interest rate. And so, one thinks of it as part of the dynamics of the LM curve. However one views that question of the IS curve versus the LM curve, the operative distinction between the two kinds of shocks is that in a disinflation shock, interest rates are up and that is why output is down. In a financial breakdown shock, output is down and that is why policy interest rates or safe interest rates are reduced. From that perspective, its very clear what the current episode is. As expectations of future output have declined, as asset prices have declined, one is seeing very substantial declines in Treasury bond yields and in the Federal Funds Rate. For those who are aficionados of such things, I will mention that for a period of a week, the five-year TIPS yield was significantly-it was negative-at one point reaching negative twenty-two basis points. There was a brief three-hour period in Japan when the one-month Treasury Bill was yielding not two basis points, not one basis point, but literally zero basis points as a consequence of various machinations in the money market that had the character of an extreme flight to safety. If one thinks about the duration and the policy response to recessions of these two kinds, they are usefully distinguished. The policy response and the dynamics of disinflation recessions are not profoundly complicated. The Fed steps on the brakes; depending on how hard the Fed steps on the brakes, the recessions duration is uncertain. At a certain point, when it is satisfied that sufficient disinflation has taken place or when it feels that other imperatives take precedence, the Fed removes its foot from the brakes, allows short-term interest rates to decline, and eventually the economy expands. Theres no great mystery about it. The length and depth of the recession is closely tied to the strength, force, and length of the Fed tightening and the speed with which it eases. Hence, there was much more disinflation to be done in 1980-82 and the recession interest rates were pushed up much further; the recession was that much more severe. The matter is much more complex when one turns to financial overextension recessions. Thinking about the limited sample of data, it falls into two broad categories. The first is the recessions that didnt happen or happened only barely. There was a pretty exciting financial crisis in 1987 and nothing really happened. There was a pretty exciting financial crisis for those involved in 1998. In neither case, if I gave you the data on unemployment, GNP, consumption, any real variable and I didnt give you the time scale and I said-What year did we have a 20% stock market crash? What year did we have a really dramatic set of dislocations in financial markets as a major hedge fund failed? You wouldnt be able to see it. Even the 2001 recession, which was associated with the bursting of the NASDAQ bubble, is a pretty minimal recession. In retrospect, with the data revised, there is no two-quarter period when GDP declined. There are two quarters in which GDP declined, but theyre separated by a quarter of modest positive growth. It is not the case that all financial crises, or even most financial crises, lead to economic downturns. Some have a natural explanation of that. Essentially, they explain that the financial sector is only one small part of the economy-that the decline in the financial sector of the economy is not of that much consequence. With reasonable policy responses, either with monetary policy or with fiscal policy, and automatic stabilizers any loss in demand can be offset. Not a typical calculation of this kind would say, suppose the stock market lost 20% of its value. If the value of the stock market is on the order of the value of GNP, thats a loss of 20% of GNP. If the marginal propensity to consume out of wealth is 4%, the loss is 8/10% of GNP-an amount that an economy would rather not lose, but hardly the difference between economic success and economic failure and something thats potentially offset if there is some policy response. There is data and evidence for the view that a significant amount of financial disruption can take place with relatively little consequence for the real economy. The difficulty is that there are other data points as well as 1987 and 1998 and 2001. There are data points that come from the United States in the aftermath of 1929, while those, perhaps, are in so different in institutional environment, with such egregious errors as to not be relevant. There are data points from Japan during the 1990s. There are any number of data points from emerging markets in which the reality of financial problems created very large losses in output. Its natural to ask, why is the response to financial crises so heterogeneous with some episodes in which they seem to have very little consequence and some episodes in which they seem to have so very much? I think the natural explanation, though its difficult to prove in any kind of conclusive way, is an idea that runs through the work of many economists and probably in recent decades most strongly through Ben Bernankes work, suggesting that financial intermediation capital is a substantial contributor to the production process. When it is destroyed, suddenly there are substantial losses, both to aggregate supply and to aggregate demand. I made this point-tried to make this point-graphic in a conversation with one of your colleagues by asking the question, suppose one considered the following macroeconomic shock. For the next six months, it will not be possible to make and complete a phone call in the United States. What would be likely to happen to the GDP of the United States and what would be likely to happen to the performance of the American economy? Its actually sort of an interesting question and I dont have a clue exactly what the right answer is. My strong suspicion is that it would really be quite a bad event for the performance of the economy. The question of whether the telephone lines would transmit bits would obviously be very important in-or it would only stop working for the human voice-would be a very important determinant. In either case, its hard to believe that there would not be substantial loss of output and significant loss of employment as well. There would be many methods for seeking to estimate the value of the losses, but I would argue that a particularly poor method would be to ask, whats the market value of all the telephone companies? Lets say the market value of all the telephone companies is a trillion dollars. If theyre not going to earn anything for a year, then their market value will go down by $400 billion dollars. So, well multiply $400billion dollars by a marginal propensity to demand-marginal propensity to consume-and well add something for the fact-and well call that lost demand. Well say, there needs to be some increased demand because we need to fix the telephones; so, thatll be some increased investment. That would, it seems to me, be the wrong mode of analysis. In some way, one would want to capture the idea that the production potential of the economy would be lower because the opportunities to generate output out of a given amount of capital and a given amount of labor would be impossible without the intercommunication that the telephone makes possible. The results, I would suggest, of that telephone shock would be lost output and would also be lost output without substantial disinflation benefit because the lost output would not come in a way that created lots of goods hanging over markets that led to declines in prices. The benefit, in terms of disinflation, of a downturn induced by the inability to make a phone call would be much less than the benefit of a similar loss of output achieved through the more standard tools of fiscal and monetary policy. I emphasize this last point because it connects with the observation with which I began yesterday-that declines in output associated with financial crisis recession, if avoidable, probably create a welfare gain of the kind that Art Okun focused so much on and of the kind that Jim Tobin emphasized when he spoke of all those Harberger triangles filling an Okun gap. And they are not susceptible to the critique that what you lose on the swings you gain on the swerves thats associated with the more conventional view of cyclical fluctuations. It should be clear, from what I have said, where I am going. My suggestion is really, to echo Ben Bernankes suggestion, that the destruction of financial intermediation capital should be thought of as reducing the economys potential to generate output and, in that process, making people poorer and reducing the level of demand as well. When that process kicks in to a substantial extent-that, I would suggest, is the occasion on which financial crises prove to be exciting events outside of the precincts of Manhattan and Chicago. The crucial question for economic policy in responding to these crises, I would suggest, is preventing that kind of destruction of intermediation capital from taking place on a large scale. That brings me to the policy task that the U.S. authorities face at the current moment. Id like to define the problem as managing and containing three separate vicious cycle mechanisms. The first is the one that I spoke about at length yesterday-what one might call the liquidation cycle. The tendency, more than a tendency, in the market for fixed-income instruments, particularly mortgage-backed securities, to some degree in the market for housing for declines in value to give rise to selling pressures that create further declines in value reinforcing the vicious cycle. The second vicious cycle, which builds on that, is what is traditionally referred to as the credit-accelerator cycle. A deteriorating financial economy leads to less lending; leads to a deteriorating real economy; leads to less capacity to pay back debt; leads to declining values of financial instruments; leads to further reductions in lending and the cycle continues. The third cycle-the third potentially destabilizing mechanism is the one thats perhaps most familiar-the Keynesian mechanism in which reduced spending leads to reduced income leads to reduced spending and on. Containing these mutually reinforcing cycles is, I would suggest now, the central challenge for economic policy. I am not in a position to make authoritative estimates of some of the relevant magnitudes and I dont want my estimates to be given more seriousness than their crudity deserves, which is why Im not projecting them on a screen. Let me give you some round numbers that are quite close to the judgment of the various investment banks and informed observers who have studied these questions. The equity capital of leveraged financial institutions in the United States totals about two trillion dollars. It totaled a little more than two trillion dollars a few months ago; it probably totals a little less than two trillion dollars today. That two trillion dollars of capital supported about twenty trillion dollars of asset holding. In other words, those institutions were levered ten-to-one; some were levered much more than ten-to-one. Fannie Mae or Freddie Mac are, for example, levered thirty-to-one. A bank with an 8% capital requirement is levered twelve-to-one; others-hedge funds pursuing certain strategies-are levered considerably less than ten-to-one. On average, the leverage works out to about ten-to-one-two trillion dollars of equity capital, twenty trillion dollars of lending. The losses that have taken place over the last nine months and the projected losses based on reasonable models of fundamentals-these are not marked-to-market losses that build in what might be market overreactions. These are estimates of what will happen to mortgage securities based on assumptions that, for example, house prices will decline by another 15% from current levels. Estimates of those total losses are about a trillion dollars. That trillion-dollar figure sounds very scary, relative to two trillion dollars of capital in the intermediation sector. But, good news-about half those losses are outside the financial intermediary sector. Theyre Bill Brainards pension; theyre the State of Nebraskas pension fund; theyre the Yale endowment; theyre life insurance companies, and the like. So, about half are held by levered intermediaries. And more good news-the levered intermediaries are mostly, sooner or later, in one way or another, going to get tax deductions of various kinds. When all is said and done, the losses of capital to the intermediation sector represent about $300 billion dollars. $300billion dollars of lost capital has been offset so far by about $150 billion dollars of capital that has been raised in Citigroups deal with Abu Dhabi and the like. Lost capital, which can be estimated with some degree of accuracy compared to the next step in this calculation, represents about $150 billion dollars. $150 billion dollars of lost capital at ten-to-one leverage means a trillion and a half dollars of lost intermediation capacity or about 7.5% of the financial asset holding that was previously taking place. Now, here comes a wild card; what should happen to the leverage of intermediaries in the face of the events of the last nine months? Well, first of all, they probably should have learned from the