Eco 202 final project

ECO 202

The 2000 – 2010 American Economy

A Macroeconomic Look

Karla Wilbur

ECO 202

Milestone One

Choose a title for your presentation.

Include your name, the course name and the assignment name.

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2000-2010 American Economy Overview

The early 2000s began with the burst of the dot-com bubble. In March of 2000, many of these overvalued dot-com businesses went under, causing the stock market to crash. GDP growth slowed from 4.1% in 2000 to 1.0% in 2001. Thus began a recession with unemployment steadily climbing each year to a high of 6% in 2003. During this time, America was dealt a blow in the form of a major terrorist attack. The World Trade Center in New York City was brought down by planes hijacked by members of al-Qaeda, based in Afghanistan. Americans, seeking revenge, overwhelming supported the government’s decision to wage war with al-Qaeda. This set in motion a chain of wars that would cost the government billions of dollars and thousands of American lives.

In an effort to lead the United States out of its recession, the Federal Reserve lowered interest rates from 6.5% at the beginning of 2001

to 1.75% in December 2001. Suddenly, mortgage rates became ideal and Americans were encouraged to borrow and to buy. As it became easier to borrow money, more people were entering the market and the median price of homes began to increase. Businesses were flourishing and unemployment rates dropped to 4.3% by 2007.

As with the dot-com bubble, the housing bubble could not be sustained. Americans who had borrowed against the value of their home when it was high found themselves unable to repay what they owed, even if they sold their property. Subprime loans left many lenders, like Frannie Mae and Freddie Mac, on the verge of bankruptcy.

In response to the financial crisis, the Emergency Economic Stabilization Act was proposed, allowing the United States Secretary of Treasury to spend up to $700 billion to purchase distressed assets, especially mortgage-backed securities, and to supply cash directly to the banks. On September 29, 2008, the bill went before the House of Representatives and was voted down. In response, the DOW fell 777.68 points which was the highest single day drop in history. After some revisions, the bill was signed into law on October 3, 2008.

In February 2009, in an effort to stimulate the economy, lawmakers enacted the American Recovery and Reinvestment Act. The purpose of this act was to provide funds to states and localities, support people in need, purchase goods and services, and provide temporary tax relief for individuals and businesses. While the effects of this act were not immediately felt before the turn of the decade, it ended up playing a large role in creating jobs and pulling the country out of the recession soon after.

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2000-2010 GDP Analysis

Source: U.S. Bureau of Economic Analysis

Year

While the chart shows GDP steadily increasing over the years, the rate of change fluctuated quite a bit during this decade. Trends in output and growth can be directly tied to a few major events that caused this decade to be labeled by many as the “lost decade”. The decade went through many business cycles facing a recession early on followed by a period of expansion, and then ending in another recession. Growth slowed from a 4.1% change in 2000 to a 1% change in 2001. 2004 saw the highest rate of change with 3.8%. When the housing bubble burst in 2007, GDP growth immediately declined to a 1.8% rate of change. As unemployment began to rise, personal consumption expenditures, especially on recreation, decreased. The decade ended with a -2.8% growth rate in 2009.

The burst of the housing bubble in 2007 caused a major shift in GDP as well. Gross private domestic investment, which includes real estate purchases, decreased by 30% in 2009 compared to 2006, with the residential sector dropping 53% in that same time period. The rate of growth for the construction industry decreased by almost 22% from 2006 to 2009. While growth slowed many times over the decade, 2009 is the only year that real GDP actually decreased. Personal consumption expenditures, gross private domestic investment, and net exports of goods and services decreased while government consumption expenditures and gross investment increased. During this recession, the government tried to increase employment and stimulate the economy by spending taxpayer dollars on government projects, like the American Recovery and Restoration Act of 2009.

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GDP & the 9/11 Terror Attacks

U.S. Stock Market Exchange closes for SIX days following the attacks on 9/11

The DOW Industrial Average drops 648 points

U.S. tourism and domestic travel declined

Domestic flights within the U.S. decreased from 56.4 million passengers in August of 2001 to 30 million passengers in September of 2001.

Military spending increases

The US enters the War on Terror.

National Defense spending increases

Change in Real GDP from 2000-2003:

Year Percentage

2000 -0.9 %

2001 3.5 %

2002 7.0 %

2003 8.5 %

When the country was attacked on September 11, 2001, the economy also faced a huge challenge. The Twin Towers in NYC were taken down by planes hijacked by terrorists. The NYSE and NASDAQ closed for 6 days following the attack, the longest shutdown since 1933. Upon reopening, the market fell by 684 points in one trading day. The airline and insurance sectors experienced the selling of their stocks at a rapid pace. American Airlines and United Airlines, carriers whose planes were hijacked during the terrorist attacks, suffered the greatest loss on Wall Street.

The hijackings also incited fear of flying and tourism and domestic travel took a sharp decline. Domestic flights in the USA dropped from 56.4 million passenger enplanements in August of 2001 to 30 million passenger enplanements in September of 2001. The end of brought with it a 13.3% decline in gross output by the American airline industry, followed by another 6.1% decline in 2002.

The hijackers were members al-Qaeda, which originated out of Afghanistan. President George Bush vowed to win the war on terrorism and launched attacks that would result in two wars throughout the remainder of the decade. This resulted in a sharp increase in national defense spending. Government consumption expenditures for national defense increased by 3.5% of real GDP in 2001 and continued to increase each year. 2003 had the highest rate of change at 8.5% of real GDP when American entered into its second war of the decade with Iraq.

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GDP & the Housing Bubble

Industry Percentage of Job Loss

Mortgage 54.5 %

Wood Product Manufacturing 35.0 %

Cement & Concrete Manufacturing 24.4 %

In 2007, the housing bubble burst. Americans who had borrowed against the value of their home when it was high found themselves unable to repay what they owed, even if they sold their property. Foreclosure filings spiked by more than 81% in 2008. The total of 861,664 families who lost their homes in 2008 is a 225% increase from 2006.

The rate of growth for the construction industry decreased by almost 22% from 2006 to 2009. As the demand for housing fell, industries that relied heavily on revenue from residential construction had to lay off workers. Employment in the mortgage industry decreased by 54.5% from 2006 to 2009. In the same period of time, there was a 35% loss of employment in wood product manufacturing and a 24.4% loss of employment in cement and concrete product manufacturing.

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Unemployment and Inflation

Source: U.S. Bureau of Economic Analysis

Unemployment rates between 2000 and 2010 follow the business cycle. When the economy is growing, jobs are evolving and unemployment is declining. As more people are employed, personal consumption increases, and the consumer price index rises. Frictional and structural unemployment play a role as workers look for jobs and businesses work to find the right employees for their organizations. However, cyclical unemployment is likely responsible for the numbers above. From 2003 through 2007, unemployment decreased as demand throughout the nation grew. During the financial crisis leading into the Great Recession, demand decreased, resulting in a higher rate of unemployment.

The inflation rate is higher when unemployment is lower, and vice versa. With more money to spend, consumers purchase more and the inflation rate rises.

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Unemployment & Inflation

The Dot-Com Bubble

Investors assume online businesses will be successful

Many e-commerce sites go to market with IPO and stock prices double, triple, and even quadruple in one day.

2000 – Many over-valued dot-com businesses fail

Leads to three year recession

Unemployment rises

2001: 4.4%

2002: 5.8%

2003: 6.0%

Federal Reserve lowers interest rates

6.5% to 1.75% in 2001

Borrowing increases and the economy grows.

Inflation begins to increase over next three years.

When the economy is growing, jobs are being created and more people are employed. As more people are employed, personal consumption increases, and the consumer price index rises. No matter how much a nation thrives, you will never see unemployment at 0%. Frictional and structural unemployment will always play a factor as workers look for jobs and businesses struggle to match candidates to the right roles within their organization. However, cyclical unemployment is likely responsible for chart above. From 2003 through the beginning of 2007, cyclical unemployment decreased as demand throughout the nation grew. During the financial crisis leading into the Great Recession, demand decreased, resulting in a higher rate of unemployment.

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Interest Rates 2000-2010

Interest rates decline during periods of recession and increase during periods of economic growth

Interest rates change in response to demand for credit, growth, and inflation

Lower interest rates mean consumers spend more and save less.

2009 – CPI fell

deflation rate of 0.36%

The value of the dollar decreased

Imports decreased by 23%

This chart shows two periods of time when interest rates declined sharply, both during recessions. During the recession from 2001-2002, interest rates fell from 9.5% to 4.3% and the rate of inflation slowed from 3.3% in 2000 to 1.5% in 2002. During the Great Recession of 2008-2009, interest rates decreased again from 8.3% to 3.3%. The major difference between this recession and the one earlier in the decade was that instead of growth slowing down, the country actually experienced negative growth and a period of deflation. The GDP declined by 2.8% in 2009. During the same year, the rate of inflation was -0.36%, or “deflation.”

When interest rates are lowered, consumers are enticed to spend more and save less. In response to more demand for credit, interest rates are raised. This can be clearly seen in the chart above for the period between 2004 and 2007. During these years, the GDP was steadily growing as well. Additionally, as the housing bubble burst and the demand for credit decreased, interest rates plummeted, directly affecting the GDP in 2009.

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Fiscal Policy and the New Millenium

1991 - 1992: Growing Deficit

1993: The Omnibus Budget Reconciliation Act enacted.

Raised taxes on wealthy

Raised gas tax

Extended limits on discretionary spending

Mandatory spending cut

1994 - 1997: Deficit begins to decrease

1998: Government runs first surplus since 1969.

$69.3 billion

Surplus continues to grow

1999: $125.6 billion

2000: $236.2 billion

Source: The White House – Office of Management and Budget

Fiscal policies have undergone many major changes in the United States, most commonly at the federal level. Just five months before President Clinton’s 1993 budget bill was passed, the Congressional Budget Office projected a 1998 deficit of $360 billion. One month after the bill was signed into law, the new estimate was down to just $200 billion. The Omnibus Budget Reconciliation Act of 1993 raised taxes on wealthy people, raised the gas tax, extended limits on discretionary spending and cut back on some mandatory spending. The CBO explained the dramatic improvement this way: “For the first time in two and one-half years, the deficit projections have taken a decided turn for the better. The reconciliation act is the reason for the improvement over the long run.” In 1998, the government ran a budget surplus for the first time since 1969. This surplus increased by 81% in 1999 and by another 88% in 2000. Judging by these events and changes to fiscal policy, we can assume that the decade was headed in the right direction.

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Fiscal Policy

The Economic Growth & Tax Relief Reconciliation Act (2001)

The Bill’s Purpose

Tax cuts

Stimulus money given to consumers

The Bill’s Goal

Encourage consumer spending

Fund the economy in the short term

The Bill’s Outcome

Economy is coming out of recession

Federal receipts decrease 12%

Federal outlays increase 21%

Surplus ends  deficit begins

Source: The White House – Office of Management and Budget

After the burst of the dot-com bubble, the economy quickly began to slide into a recession. In response, Congress and President George W. Bush passed The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). This expansionary policy enacted wide-spread income tax cuts that reduced tax liabilities for almost every tax return. It initially helped the suffering economy by stimulating spending during the 2001 recession. It also gave income tax relief to families who would spend their money, further stimulating the economy. This increase in demand helped boost the economy and pull it out of recession. As shown in the chart above, Government receipts decreased by 12% between 2000 and 2003 while outlays increased by 21% in the same time. This resulted in the end of the budget surplus, leading the United States into the greatest deficit in history and a deficit we still find our country in today.

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Fiscal Policy

The American Recovery & Reinvestment Act (2009)

Source: The White House – Office of Management and Budget

The Bill’s Purpose

Individual tax cuts

Direct relief to state governments and individuals

Extended unemployment insurance, health coverage, and food stamps

Investments in environmental protection and infrastructure

The Bill’s Negative Effects

Contributed to largest deficit in history

$1.4 trillion

The Bill’s Positive Effects

Increased GDP 2.5%

Created 2.3 million jobs

Decreased unemployment

Prevented recession from becoming a full-blown depression

President Obama enacted the American Recovery and Reinvestment Act of 2009 (ARRA). This expansionary policy was in response to the recession brought on by the bursting of the housing market, discussed in slide 5. America was facing the worst economic and financial crisis since the Great Depression. In 2008, we saw the loss of trillions of dollars of household wealth and 4.6 million private sector jobs and GDP was rapidly falling. The act, signed into law on February 17, 2009, included individual income tax cuts, direct relief to state governments and individuals, extending unemployment insurance, health coverage, food assistance programs, and investments in transportation, environmental protection, and other infrastructure that were thought to provide long-term economic benefits.

This increase in government spending combined with a decrease in taxes created the largest deficit the United States had ever seen at $1.4 trillion. However, it contributed to stimulating the economy, increasing the GDP, and prevented the recession from becoming a full-blown depression. The increase in government spending had a multiplier effect in subsequent transactions as it passed through the broader economy. According to Congressional Budget Office, the act raised the nation's GDP from 2% to 2.5% between the fourth quarter of 2009 and the second quarter of 2011. The CBO also estimates that the act was directly responsible for the creation of 2.3 million jobs in 2010. Government spending created new jobs, business tax relief allowed more companies to retain and/or hire workers and individual tax breaks and extended unemployment benefits put more money back in the pockets of consumers.

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Calculating Inflation

Changes throughout the Decade

2000 and Prior:

Consumer Price Index (CPI)

2000-2004:

Personal Consumption Index (PCE)

2004-Current:

Core-PCE

(excluding prices of food and energy)

Sometimes, monetary policies can help the Federal Reserve achieve one goal, while simultaneously impeding its other goals. When the Federal Reserve feels as though inflation is increase at an alarming rate, it can take action to slow it down. However, when the Federal Reserve increases interest rates to reduce the inflation rate, a recession can occur. This causes a slow in growth in aggregate demand, which can increase unemployment and decrease GDP.

One major change that took place regarding monetary policy was in regards to the way inflation was calculated. Prior to 2000, the inflation rate was always calculated by the Consumer Price Index (CPI). However, in 2000, the Chairman of the Federal Reserve, Alan Greenspan, began using the Personal Consumption Expenditure (PCE) to calculate the rate of inflation instead. PCE is the measurement of all goods and services consumed in the United States, including purchases made by consumers, employers, and federal programs. Chairman Greenspan argued that the PCE was more comprehensive and would be more consistent in the long run by more easily allowing revisions to be taken into account.

In 2004, Chairman Greenspan again changed the way inflation was calculated by removing the cost of food and energy. The belief was that the price of food and energy fluctuated by causes unrelated to general inflation and that these prices count not be controlled by monetary policy. The Federal Reserve began using the core-PCE price index to calculate inflation. The core-PCE is defined as “personal consumption expenditures (PCE) prices excluding food and energy prices” (The Bureau of Economic Analysis, 2016). As you can see in the chart above, there is a major difference between CPI, PCE, and core-PCE. While both CPI and PCE were showing the economy was in a significant period of deflation from the end of 2008 through the beginning of 2009, core-PCE continued to show a rate of growth.

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Monetary Policy

The New Millenium

1990 – 2000 was a period of relatively stable economic growth, inflation rate, and joblessness

CBO’s forecast for 2000-2009 shows anticipated continual growth (report released January 1999)

GDP growth rate: 2.3% average per year

Inflation rate: 2.6% average per year

Unemployment rate: 5.7% average per year

Monetary policies are based off of forecasted information

Both upcoming recessions were unanticipated

The Federal Reserve has the right to act “so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates”. They have four main goals: to establish price stability, to maintain high levels of employment, to ensure the stability of financial markets and institutions, and to encourage stable economic growth. The actions that the Federal Reserve takes to achieve these goals are monetary policy.

The federal funds rate is the interest rate at which banks lend money to other banks in order to meet the required reserve. These loans are usually very short term and often happen overnight. Although the Federal Reserve can not actually set the federal funds rate, it does have the ability to manipulate it indirectly. This is done by raising or lowering the discount rate at which the Federal Reserve loans money. Essentially, if the Federal Reserve lowers the discount rate below the federal funds rate, banks would be more likely to borrow from the Federal Reserve when they need money. This causes the federal funds rate to decrease in order to compete. However, if the discount rate is above that of the federal funds rate, banks will likely choose to borrow from each other instead, causing the federal funds rate to increase. Therefore, the discount rate and the federal funds rate usually rise or fall together.

The chart above shows the effective federal funds rate from 1995 through the end of 1999. While the rate spiked and dipped throughout these years, it remained fairly stable. This is a direct reflection of the stability in economic growth, the inflation rate, and joblessness that occurred throughout these years. Because the Federal Reserve’s essential function is to stabilize output, employment, and inflation, the 1990s were arguably a relatively easy decade for the Federal Reserve to handle. In January of 1999, the Congressional Budget Office (CBO) released a report outlining the economic and budget outlook for the years 2000 through 2009. In it, they forecasted that the GDP would grow by an average of 2.3% per year, inflation as measured by the consumer price index would increase by 2.6% per year, and that unemployment would average 5.7% per year. The Federal Reserve can only enact monetary policies based on forecasted information.

Because the forecast leading into the next decade showed continual growth, the Federal Reserve had no way of knowing that two recessions were on the horizon.

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Monetary Policy

The Housing Bubble

Monetary Policy:

Federal Reserve lowers interest rates from 6.5% to 1.75% in 2001

Goals:

Increase the money supply

Increase borrowing

Increase spending

Stimulate the economy

Negative Effects:

Higher demand leads to increase housing prices

Between 2000 to 2006

Housing prices increase over 200%

Rental prices increase only 25%

The housing bubble is created

Lower interest rates allowed for subprime lending,

creating a financial crisis when borrowers

could not repay

Positive Effects:

Lower interest rates result in banks lending more and consumers borrowing more

More first-time home buyers could obtain mortgages

Housing market boomed

Employment related to the housing/construction industry thrived

After the dot-com bubble burst, the economy experience a slight recession. This situation was compounded by the terrorist attacks in New York City on September 11, 2001. In an effort to stimulate spending, the Federal Reserve lowered interest rates from 6.5% at the beginning of 2001 to 1.75% in December 2001, applying downward pressure to the federal funds rate. Changes in the federal funds rate affects banks, which in turn affect mortgage rates. Historically low mortgage rates enabled more first-time homebuyers to obtain mortgages and enter the housing market. With so many consumers in the housing market, housing prices soared and employment related to the housing/construction industry thrived. The rate of unemployment in the construction industry decreased from 14% in January of 2003 to 4.5% in October of 2006. The gross output in the housing industry increased by 68% in the same time frame.

However, this monetary policy had negative effects as well. These low interest rates created capital liquidity allowing for banks to provide borrowers with the necessary funds to buy a home. There were many people who wanted to invest in a home but were excluded from securing favorable financing due to the underwritten guidelines used by the prime loan mortgage companies. The increase in capital coupled with the increase in demand for mortgages led most prime rate mortgage companies to relax their guidelines. Subprime mortgages are defined as a “type of loan granted to individuals with poor credit histories (often below 600), who, as a result of their deficient credit ratings, would not be able to qualify for conventional mortgages”. (Investopedia, 2016). At the time, lenders saw subprime mortgages as less risky than they were. Rates were low, the economy was thriving and borrowers were making payments on time. The size of the subprime loan market rapidly increased. In 1995, it was estimated that there were $65 billion in subprime mortgages. However, by 2007, of the $10 trillion in outstanding mortgages, subprime mortgages accounted for $1.3 trillion.

Typically, rental prices and housing prices increase at about the same rate. However, with the increase in demand for homes, housing prices began to surge. The graph above shows the correlation between housing prices and rental prices. As you can see, they remain very close together until 2001 when housing prices begin to drastically increase. From 2000 to 2006, housing prices increased by over 200% while rental prices increased by only 25% in the same time frame.

These events eventually led to the bursting of the housing bubble and the Great Recession.

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Monetary Policy

Bank Reserves

2008

Federal Reserve pushes target for federal funds rate to nearly zero

Federal Reserve begins paying 0.25% interest on bank reserves

Goals:

Increase reserves to meet demand

Banks would lend reserves to households and firms

Increase spending

Stimulate failing economy

Results:

Banks hesitant to lend money

Banks begin stockpiling reserves instead of lending to households and firms

Total bank reserves rise from < $50b in

2008 to > $900b in 2009

Before the Great Recession, Congress passed the Financial Services Regulatory Relief Act of 2006. This act authorized the Federal Reserve to begin paying interest to banks on the balance of their reserves. Although this legislation wasn’t supposed to go into effect until October 1, 2011, the financial crisis prompted quicker action. The failure of many high profile financial institutions in September of 2008 caused a huge sense of instability in the financial system. The Emergency Economic Stabilization Act of 2008 authorized the Federal Reserve to begin paying 0.25% interest on reserve balances. According to the Board of the Federal Reserve, “the payment of interest on excess reserves will permit the Federal Reserve to expand its balance sheet as necessary to provide the liquidity necessary to support financial stability while implementing the monetary policy that is appropriate in light of the System’s macroeconomic objectives of maximum employment and price stability.”

The intention behind the interest payments was to increase bank reserves and avoid a potential bank run. The Federal Reserve was hoping that banks would then lend these reserves to households and firms. These households and firms would then spend the money, stimulating the economy, increasing jobs, and raising GDP. However, banks were hesitant to loan to anyone without stellar credit and once the Federal Reserve was authorized to pay interest on reserves, the amount of money banks kept in their reserves began to increase dramatically. As you can see in the chart above, reserve balances with Federal Reserve banks hovered consistently at just below $50 billion from 2000 through 20008. As indicated by the jagged peaks, once these reserves began earning interest, banks began stockpiling excess reserves instead of loaning out these funds. By 2009, Federal Reserve banks balances were over $900 billion.

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References

Bureau of Economic Analysis. (2016). National Data. Retrieved from http://www.bea.gov/iTable/index_nipa.cfm

Federal Reserve Bank of New York. (2016). Term Asset-Backed Securities Loan Facility. Retrieved from https://www.newyorkfed.org/markets/talf.html

Focus Economics. (2016). U.S. Economic Outlook. Retrieved from http://www.focus-economics.com/countries/united-states

Geier, Ben. (2015, March 12) What did we learn from the dotcom stock bubble of 2000? Time. Retrieved from http://time.com/3741681/2000-dotcom-stock-bust/

Board of Governors of the Federal Reserve System. (2015, November 24). Term Asset-Backed Securities Loan Facility. Retrieved from https://www.federalreserve.gov/monetarypolicy/talf.htm

Board of Governors of the Federal Reserve System. (2016). Bank Prime Loan Rate. Retrieved from https://fred.stlouisfed.org/series/MPRIME

White House, The. (2016). Historical Tables. Office of Management and Budget. Retrieved from https://www.whitehouse.gov/omb/budget/Historicals

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References Continued

Hubbard, R. Glenn & O’Brien, Anthony Patrick. (2015). Macroeconomics. Pearson Education Inc. Retrieved from https://view.ebookplus.pearsoncmg.com

Feldstein, Martin. (2002). Tax Cuts, Rate Cuts Put the Economy Back on Track. Wall Street Journal Online. Retrieved from http://www.nber.org/feldstein/wj031302.pdf

Meth, Madeline. (2011, March 7). RELEASE: The Real Heroes of the 1998 Budget Surplus: Clinton and His Economy. Center for American Progress. Retrieved from https://www.americanprogress.org/press/release/2011/03/07/14349/release-the-real-heroes-of-the-1998-budget-surplus-clinton-and-his-economy/

Nesvisky, Matt. (2001, December 1). U.S. Monetary Policy During the 1990s. The National Bureau of Economic Research Digest. Retrieved from http://www.nber.org/digest/dec01/w8471.html