ZLB - history of liquidity trap and ZLB

Question 1

What was the percentage drop in UK output during the Great Recession?

Answer 1

Near 7% drop in UK output in less than 18 months

Question 2

What happened to UK output by 2013 compared to projections made in 2008?

Answer 2

14% smaller than projected based on historical growth assumptions

Question 3

What was the total amount of assets purchased by the UK from March 2009 to January 2010?

Answer 3

£200 billion of assets purchased - in response to the Great Recession (Joyce et al., 2011)

Question 4

What percentage of annual nominal GDP did the £200 billion asset purchases represent?

Answer 4

Around 14% of annual nominal GDP

Question 5

How does evidence suggest QE asset purchases had economically significant effects?

Answer 5

Most clear-cute evidence = impact from asset prices:
- Gilt yields depressed by around 100 basis points
- Policy had economically significant effects - equivalent to a 150 to 300 basis point cut in Bank rate
- But there is considerable uncertainty around precise magnitude of impact

Question 6

What was the average annual deflation rate in the US during the Great Depression (1930-1932)? (Svensson, 2003)

Answer 6

About 10 percent per year

Question 7

What happened to industrial production and GDP during the Great Depression?

Answer 7

Industrial production fell by 50 percent and GDP by almost 30 percent

Question 8

What role did monetary factors play in the Great Depression?

Answer 8

Crucial role in the onset and prolongation of the Great Depression (Meltzer, 2003)

Question 9

What was Japan’s national debt as a percentage of GDP at the end of 2001 & what caused this? (IMF, 2002)

Answer 9

Close to 150 percent of GDP and still increasing
- Caused by expansive fiscal policy, w big fiscal deficit - didn’t end in stagnation but rather huge national debt

Question 10

What monetary policy action did the Bank of Japan take from February 1999 to August 2000 and again from March 2001 to now?

Answer 10

Lowered the interest rate to zero

Question 11

What are the consequences of prolonged deflation? (Svensson, 2003)

Answer 11

• The real value of nominal debt rises = may cause bankruptcies for indebted firms / households and fall in asset prices
• Commercial banks’ balance sheets deteriorate when collateral losses value and loans turn bad
• Unemployment may rise - if nominal wages are rigid downwards, deflation = real wages X fall but increase = further increases unemployment
• All ^^ contributes to further fall in AD, further increase in deflation and further increase in real IR, and bring prices and economy down in deflationary spiral

Question 12

True or False: The influx of properties in the US sub-prime mortgage market caused house prices to crash

Answer 12

True - Keynesian view

Question 13

What is the ‘savings glut’?

Answer 13

Excess savings leading to a deficit in demand
- situation where the global supply of savings exceeds the global demand for investment

Question 14

What was the impact of monetary policy from 2002-2006 according to Taylor?

Answer 14

Monetary policy was too loose
- CBs maintained policy rate for too long below level that would’ve been produced from simple rule specifying reaction to an y gap and inflation
- had MP makers not deviated from this rule, the rise in asset prices (and subsequent financial crisis) could have been avoided
- suggests that monetary excesses were main cause of booms and busts

Question 15

What does the ‘exorbitant privilege’ refer to in the context of the USD?

Answer 15

The dollar’s reserve currency status allowing the US to finance large deficits
= US private and public sectors were able to borrow and spend more heavily, with smaller increases in IR (or less currency depreciation) than otherwise

Question 16

What type of capital inflows did Emerging Europe receive before the crisis?

Answer 16

Mostly in the form of FDI (in central and E. Europe) and bank credit (in the Balkans)
- these capital inflows provided much-needed financing of investment in traded goods sectors and infrastructure, aimed at taking advantage of opportunities created by integration into the EU and enabled rapid convergence of living standards in these new member states towards the rest of the EU
- In some cases, particularly the Baltics, capital flows supported credit booms in real estate, accompanied by overheating, appreciation of real exchange rates, and widening external imbalances

Question 17

What was the Bank of England’s policy rate reduction in November 2008 as policy response to the GFC?

Answer 17

Reduced policy rate by 150 basis points
= aiming to stimulate growth and investment to prevent deeper recession
- previous standard policy change for last 10 yrs was 25 points and previous average rate was 5%
- by 2009, CB IR were 0.5% in UK, 0-0.25% in USA and 1% in Euro area
- Bank of Japan policy IR stuck at 0.1% for > decade

Question 18

Fill in the blank: The Bank of Japan’s policy interest rate was stuck at ______ for over a decade.

Answer 18

0.1%

Question 19

What was the policy response of central banks during the crisis?

Answer 19

Implemented large interest rate cuts

Question 20

What was the GDP growth rate assumption in the UK before the Great Recession?

Answer 20

Historical average of 2.5% per annum

Question 21

What did the asset purchases signal to the market?

Answer 21

The Bank would continue to loosen monetary policy

Question 22

What was the impact of quantitative easing on Bank rate?

Answer 22

Equivalent to a 150 to 300 basis point cut

Question 23

What were the consequences of rising real wages during deflation?

Answer 23

Increased unemployment

Question 24

What did the influx of properties lead to in the US housing market?

Answer 24

Fire-sale of houses

Question 25

What was the main consequence of bank runs like Northern Rock?

Answer 25

Savers couldn't discriminate between solvent and insolvent banks

Question 26

What did the capital inflows in new EU member states lead to?

Answer 26

Credit booms in real estate

Question 27

What was Japan’s “quantitative easing” from March 2001?

Answer 27

After long indecisiveness, Japan attempted ”Q E” - substantial expansion of monetary base - during 2 years up to spring of 2003, monetary base was increased by about 50% (Bank of Japan, 2003) - but these steps weren’t sufficient to induce a recovery

Question 28

What is the Keynesian / consensus view of the Great Recession?

Answer 28

1. 2007: there was a significant wave of defaults in the US sub-prime mortgage market 2. The influx of properties on the market caused the average house price in the US to crash, resulting in the fire-sale of houses (where houses were sold for less than the value of the mortgage) and significant bank losses 3. Some US banks became insolvent (e.g. Lehman Brothers in 2008) and international banks that had bought mortgage securities from American Banks (e.g. RBC) also encountered difficulties 4. Savers and investors couldn’t discriminate between banks that were safe (i.e. solvent with cash on their balance sheet) and those that were unsafe (i.e. exposed to losses and at risk of bankruptcy) there were some bank-runs (e.g. Northern Rock in the UK) 5. Once savings are removed from banks, banks can no longer recycle global savings as investment and consumption loands, leading to excess savings (savings glut) and a deficit in demand 6. Overall demand in the economy declines sharply; IS shifts left, output decreases, employment decreases, etc.

Question 29

Contributing factors to the GFC

Answer 29

No single factor can explain the crisis / account for the difference in countries’ experiences leading up to it (Faruqee et al., 2009) - savings glut (once savings are removed from banks, banks can no longer recycle global savings as investment and consumption loans, leading to excess savings (savings glut) and a deficit in demand) - accommodative MP - USD as reserve currency - in sufficiently countercyclical policies by capital-importing countries

Question 30

Impact of Savings Glut

Answer 30

1) 2005-07: reserve accumulation amounted to almost 2% of global GDP per year, or 8% of global saving, up significantly from the previous 3-year period 2) Almost 1/3 of global reserve accumulation was accounted for by fuel exporters; the primary motives was to save the proceeds from exploitation of a depletable resource during a commodity price boom to provide for higher consumption by future generations, especially given that a too rapid build-up of domestic spending would hit absorptive capacity limits and imply overheating 3) High rates of official reserve accumulation through intervention in foreign-exchange markets could, in principle, foster higher domestic savings provided that the country authorities sterilize the domestic liquidity created by intervention through additional sales of government or central bank paper to the private sector 4) There is evidence to suggest that heavy foreign-exchange market intervention (above and beyond the amounts needed for consumption smoothing by commodity exporters and for precautionary purposes) may have contributed significantly to the recent rise in global savings and downward pressure on interest rates

Question 31

What did the Bank of International Settlements say about setting MP by only looking at CPI inflation and the output gap?

Answer 31

Said it was fundamentally too narrow an approach (as was done at the time) - MP should’ve leaned more actively against unsustainable asset price rises / developments which raised financial vulnerability - even at the cost of some more variability in inflation and y - by accommodating relaxation in financial conditions implied by long term IR and aggressive financial innovations, MP makers allowed risk of large bust to grow - monetary conditions should have been tightened earlier and more vigorously, even though CPI inflation was well under control

Question 32

What is the primary assertion made by Farugee et al., 2009 regarding monetary policy and house-price booms?

Answer 32

If monetary policy had been the fundamental cause of house-price booms, there would be a systematic relationship between monetary policy conditions and house-price gains across countries = This suggests that monetary policy alone cannot explain fluctuations in house prices

Question 33

What was observed regarding the association between monetary policy stance and house-price increases across countries?

Answer 33

There is essentially no association between the measures of monetary policy stance and house-price increases in the full sample of countries = This indicates a disconnect between monetary policy and housing market dynamics

Question 34

Which countries had low real policy rates but strong house-price growth according to the findings?

Answer 34

Ireland and Spain ## Footnote These countries experienced significant house-price increases despite having lower policy rates.

Question 35

Which countries had relatively high real policy rates while still experiencing strong house-price growth?

Answer 35

Australia, New Zealand, and the United Kingdom ## Footnote This illustrates that high policy rates do not necessarily suppress house-price growth.