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  • 1. Punch Bowls & Bubbles
    ECON 635 Team UK
  • 2. What are these “Bubbles”?
    Bubbles in Economics are “trade in high volumes at prices that are considerably at variance with intrinsic values” (trade in products or assets with inflated values)
    Post-Bubble economies are hard to manage:
    Poor response to falling interest rates
    The greater the debt buildingthe more difficult the recovery
  • 3. Why do they occur?
    Still being debated:
    Some economists deny that bubbles occur
    Some economists believe it might be caused by price coordinationor emerging social norms. Because it is often difficult to observe intrinsic values in real-life markets, bubbles are often conclusively identified only in retrospect, when a sudden drop in prices appears (crash or bubble burst)
  • 4. The Issue
    Individual banks and financial institutions can act prudently.
    However, collectively they can contribute considerable risks and negatively shock the aggregate economy.
  • 5. The Schools of Thought
    Implement the use of macroprudential tools with new capital rules (REGULATE)
    To leave it alone (DEREGULATE)
  • 6. Advantages
    Regulation of financial markets would allow policymakers to limit risky behavior of individual banks to prevent the collapse of bubbles
    Deregulation would allow for economic freedom
  • 7. Problems with Regulation
    “To embed the rules, regulators will need models capable of identifying risks across the financial system, not just in banks. And those models would need to be sophisticated enough to map the linkages between different asset classes and counterparties, while also calculating the likelihood of a boom turning to bust.” –WSJ 9/5/10
  • 8. “Punch Bowls”
    Pool of Liquidity that has kept US economy out of depression
    Easy money via low Federal Funds Rate
    Idea of “Quantitative Easing”
    FED buys up assets, mainly Treasury Bonds
  • 9. Need for Exit Strategy
    Trillions of dollars in stimulus, what next?
    Historically: Drain the Punch Bowl
    Problem of hyper-inflation
    If FED raises interest rates too quickly
    When should FED sell off assets?
    Concern that party will spin out of control
  • 10. Bernanke on Timing
    Critical to tighten monetary policies and restrain credit once economy begins to “heat up”
    ”…we have been working to ensure that we have the tools to reverse, at the appropriate time, the currently very high degree of monetary stimulus. We have full confidence that, when the time comes, we will be ready to do so."
  • 11. Alternative Solutions
    Reverse Repurchase Agreements
    FED sheds off assets, central bank takes them out of circulation
    FED promises to repurchase assets at later date
    Assets on FED balance sheet remains unchanged, liabilities shift from providing resources today to providing in future
  • 12. Dow Jones Industrial Average
  • 13. Bubbles and Fed’s reactions
    1973 Oil crises:
    OPEC stopped the shipment of Oil to the U.S
    Started Oct. 1973, ended Mar. 1974
    Dow lost more than 45% of its value.
    Fed’s reaction:
    More focus on controlling inflations
    Increased the fed funds rate up to 12.91% in Jul. 1974.
    Was not affective, it may also longer the recession
  • 14. Bubbles and Fed’s reactions
    2000 Dot-Com bubble:
    Internet stocks was growing rapidly in the 90s
    But the growth stopped in Mar. 200
    NASDAQ was more affected than Dow.
    Fed’s reaction
    Wanted to keep the growth
    Lower the funds rate as low as 0.98 in Dec. 2003 (Jul. 2000: 6.54)
    Helped the growth, but it might also caused the next bubble
  • 15. Bubbles and Fed’s reactions
    Subprime Mortgage Crisis:
    Started 2007
    Housing price dropped
    People could not pay mortgages.
    Banks start write-off their mortgage loans
    Fed’s Reaction:
    Helped the banks with emergency funds
    Lower the fed funds rate to almost 0.00% (5.25 in Jan. 2007)
    Expect to stay at 0.00% for long time
  • 16. Expanding Roles of the Federal Reserve
  • 17. Monetary Policy
    1913- Serve as a lender of last resort in times of crisis. Provide elastic currency.
    1950s- Assume a proactive macroeconomic role… “Take away the punch bowl just as the party gets going.”
    1977- Promote maximum employment and stable prices
  • 18. Regulation
    1913 Establish effective supervision of banks
    1956 Federal Reserve is responsible for holding companies
    1968-77 Protect consumer rights and promote fair lending
    2008 Expand regulation to protect against complex risky assets and improve containment of systemic risk
  • 19. Is the Federal Reserve Overextended?
    Is it realistic to ask for a chairman versed in macroeconomics as well as a dynamic banking system?
    Is it possible to separate the interests of the FED, the Government, and Corporate America?
    Should the FED be responsible for preventing asset bubbles?
  • 20. Thank You!
    Anthony Liang
    David King
    Andy Irish
    Ted Gagner