Principles of Macroeconomics

Macroeconomics, March 30, 2009, Martha Stuffler

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Principles of Macroeconomics

Economic Crisis


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WHAT ARE WE DOING

Fiscal PolicyMonetary PolicyLegislative SummariesBush Tax Rebate 2008Obama Tax CreditTARP (Troubled Asset Relief Program)American Recovery and Reinvestment Act$410B Bill to Fund Federal GovernmentMaking Home Affordable ProgramKeynesian Multiplier PrincipleBailouts


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FISCAL POLICY

Government’s use of its spending and taxing powers

Determined by the President and Congress for the national

economy and by state legislatures


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MONETARY POLICY

Fed’s use of its tools to change interest rates and

the money supply to influence credit conditions

in the economy


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MONETARY POLICY

Given that interest rates are about as low as they can go,

we will focus on the effects of fiscal policy to

stabilize the economy


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LEGISLATIVE SUMMARIES

National Association of Tax Professionals

www.natptax.com/tax_act_summaries.html


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Summary of the American Recovery and Reinvestment Act of 2009 [HR 1]

Summary of the Worker, Retiree, and Employer Recovery Act of 2008 [HR 7327]

Summary of the Emergency Economic Stabilization Act of 2008, Energy Improvement and Extension Act of 2008 and Tax Extenders and Alternative Minimum Tax Relief Act of 2008 (HR 1424)

Summary of the Housing Assistance Tax Act of 2008 (H.R. 3221)

Summary of the Heroes Earnings Assistance and Relief Tax Act of 2008 (H.R. 6081)


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Summary of the Food, Conservation, and Energy Act of 2008 (AKA The Farm Bill)

Summary of the Economic Stimulus Act of 2008 (H.R. 5140)

Treasury Department news release with examples of how the Economic Stimulus Act of 2008 will benefit Americans

Summary of the Mortgage Forgiveness Relief Act of 2007 (H.R. 3648)

Summary of the Small Business Work Opportunity Act of 2007 (H.R. 2206)


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WHAT ARE WE DOING

Bush Tax Rebate 2008

February 2008, Congress approved a $168B economic stimulus plan to help stave off economic recession

Tax rebates for many citizens

Citizens must have filed a 2007 tax return to be eligible for a rebate


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WHAT ARE WE DOING


$600 for individuals with incomes of up to $75,000

Partial rebates for those earning $75,000 to $87,000

Couples: $1,200 for those making up to $150,000

Families: additional $300 per child (up to age 17)

Partial rebates for couples making between $150,000 and $174,000

$300 for low income people—disabled veterans, veterans' widows, senior citizens


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WHAT ARE WE DOING


“Impact of the 2008 Rebate” – August 15, 2008 article by Christian Broda and Jonathan A. Parker, professors for University of Chicago and Northwestern University, respectively reported:

This spring, the US government handed out $100 billion in tax rebates. Twentieth century economic thinking – permanent income hypothesis, Ricardian equivalence, and the like – suggests that most would have been saved, as Martin Feldstein recently argued. Not so. Recent research shows that the typical family increased spending by 3.5% when the rebate arrived, boosting overall nondurable consumption by 2.4% in 2008Q2. The number should be 4.1% in 2008Q3.


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Early in 2008, in response to slowing economic growth, the US federal government enacted an economic stimulus package consisting mainly of a $100 billion tax rebate program. By 1 July 2008, more than 70 million American households had received tax rebates of $950 on average. The hope of policymakers was that by putting money directly back into the hands of US households, they would increase spending levels and avoid (or at least mitigate) the severity of the slowdown.


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WHAT ARE WE DOING

OBAMA TAX CREDIT

Refundable tax credit of up to $400 for working individuals and up to $800 for married taxpayers filing joint returns

Phased out for taxpayers with modified adjusted gross income in excess of $75,000, or $150,000 for married couples filing jointly


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OBAMA TAX CREDIT

Tax credit will appear April 2010 to offset the decreased tax withholding

Cost estimate is $140 billion over the next two years

Goal to increase consumer spending


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OBAMA TAX CREDIT

What is the difference between the Bush Tax Rebate and the Obama Tax Credit?

Do you believe the effects will differ or will they be the same?


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TARP (October 2008)Troubled Asset Relief Program

Division A - Emergency Economic Stabilization Act of 2008

Division B - Energy Improvement and Extension Act of 2008

Division C - Tax Extensions and Alternative Minimum Tax Relief


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WHAT ARE WE DOING


$700B to US Treasury -- purchase or insure (ANY) troubled assets and to cover all

administrative expenses of purchasing, insuring, holding, and selling those assets

ANY troubled assets includes mortgages,auto loans, credit card loan portfolios, and

school loan portfolios


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WHAT ARE WE DOING


US Treasury could bailout foreign commercial and central banks

For example, Bank of Shanghai transfers its toxic assets to the Bank of Shanghai in Los Angeles

which can then sell them to the US Treasury

A provision to say if it wasn't owned by an American entity or even a subsidiary of an American entity, the Treasury could

not buy it, provision was rejected


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Division B - Energy Improvement and Extension Act of 2008

Provided tax incentives related to energy and fuel production and energy

conservation

CBO estimated that tax revenues would fall by $6.8 billion, outlays would rise by about $0.2 billion, and increase deficits by about

$7 billion


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WHAT ARE WE DOING


Extend AMT (alternative minimum tax) relief for 2008

AMT imposed 1969 to ensure the richest 155 Americans paid some income tax of at

least 26% or 28% by getting rid of tax deductions that was lowered their tax rates


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Extend/modify other expiring tax provisions, provide tax relief for regions of the country affected by severe storms earlier in 2008, and provide payments to state and local governments for support to rural schools and other county programs

Division C would reduce revenues by about $105.2B, increase outlays by $7.1B, and increase projected deficits by about $112.3B


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Division C, section 512 would impose a private-sector mandate on group health

plans and issuers of group health insurance by prohibiting them from

imposing treatment limitations or financial requirements for mental health benefits that differ from those placed on medical

and surgical benefits


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Does anyone notice that TARP (Troubled Asset Relief

Program of October 2008) contains many provisions that

have nothing to do with troubled assets within the

banking/mortgage industry ?


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WHAT ARE WE DOING

Return to Division A: Emergency Economic Stabilization Act of

2008

Created program to allow the government to insure, instead of buying, some troubled assets held by banks

Established an oversight board to monitor the Treasury's use of funds


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Return to Division A: Emergency Economic Stabilization Act of 2008

Increased FDIC Insurance from

$100,000 per account to $250,000

account until Dec. 31, 2009


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WHAT ARE WE DOING

American Recovery and Reinvestment Act of 2009

Economic stimulus package that was passed by Congress on Feb. 13, 2009 and signed into law

by President Obama on Feb. 17

CBO estimates the cost as $787B over the 2009-2019 period


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American Recovery and Reinvestment Act of 2009 Summary

Tax Relief and Tax Cuts $288 billion

State and Local Aid $142 billion

Federal Spending Programs $357 billion

Total $787 billion


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American Recovery and Reinvestment

Act of 2009 Various Provisions

$116 billion: New payroll tax credit of $400 per worker and $800 per couple in 2009 and 2010

$70 billion: One year increase in AMT (Alternative Minimum Tax) floor to $70,950 for joint filers for 2009


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$1.7 billion: Deduction of sales tax from car purchases, not interest payments, phased out for incomes above $250,000.


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American Recovery and Reinvestment Act of 2009 Various Provisions

$15 billion: Expansion of child tax credit -- A $1,000 tax credit to more families (even those that do not pay income taxes)

How could a family not pay any federal income taxes?


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What is the difference between a tax credit and a tax deduction?


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What percent of US households pay Federal Income Taxes?

What percent of US households do not pay any Federal Income Taxes?


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$14 billion: Expanded college credit to provide a $2,500 expanded tax credit for college tuition and related expenses for 2009 and 2010--credit is phased out for couples making more than $160,000


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$4.7 billion: Excluding from taxation the first $2,400 a person receives in unemployment compensation benefits in 2009

$4.7 billion: Expanded earned income tax credit to increase the earned income tax credit — which provides money to low income workers — for families with at least three children.

$4.3 billion: Home energy credit to provide an expanded credit to homeowners who make their homes more energy-efficient in 2009 and 2010. Homeowners could recoup 30 percent of the cost up to $1,500 of numerous projects, such as installing energy-efficient windows, doors, furnaces and air conditioners.


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WHAT ARE WE DOING


$6.6 billion: Homebuyer credit of $8,000 refundable credit for all homes bought between 1/1/2009 and 12/1/2009 and repayment provision repealed for homes purchased in 2009 and held more than three years. This applies to first-time homebuyers—those who have not owned a home in the last 3 years.


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American Recovery and Reinvestment Act of 2009 Various Spending Provisions

Healthcare $148 billion

Education $91 billion

Environment $7 billion

Energy $61 billion


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American Recovery and Reinvestment Act of 2009 Various Spending Provisions

Aid to low income workers, unemployed and retirees (including job training) $83 billion

Infrastructure Investment $81 billion

Investment into government facilities and vehicle fleets $30 billion


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WHAT ARE WE DOING

$410 Billion to Fund Federal Government

Infamous “earmarks” bill signed March 11, 2009

OMB defines earmarks as: Funds provided by the Congress for projects or

programs where the congressional direction (in bill or report language) circumvents Executive Branch merit-based or competitive allocation processes, or specifies the location or recipient, or otherwise curtails the ability of the Executive Branch to manage critical aspects of the funds allocation process


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OBM reports that earmarks Include:

Add-ons, Carve-outs and funding provisions that do not name a recipient, but are so specific that only one recipient can qualify for funding


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Supposed to have been completed last fall, but Congress and President Bush

could not agree

1,132-page spending bill that combines 9 spending bills to fund foreign aid and the annual operating budgets of every Cabinet department except for Defense, Homeland Security, and Veterans Affairs that were funded last year


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Independent watchdog group Taxpayers for

Common Sense found 8,570 disclosed earmarks in the bill, worth $7.7 billion

Only five senators did not add pet projects to the measure, including Republicans McCain, DeMint and Tom Coburn, and Democrats Feingold and McCaskill


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Numerous policy changes, including shutting down a program allowing Mexican trucking companies to operate beyond U.S.-Mexico border zones and easing rules on Cuban-Americans traveling to the island to visit relatives


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$410 Billion Bill Provisions

Increases many government agencies’ operating budgets 10% or more above fiscal 2008 levels

One contentious item was the Washington DC school voucher program provides 1,700 low-income students with the equivalent of a $7,500 grant to attend a private school


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Increases for mass transit, public housing, the National Institutes of Health, Head Start and the Pell grant program

The Food and Drug Administration would receive nearly $335 million more than it did in fiscal 2008

The supplemental nutrition program for women, infants and children, known as WIC, would grow by $1.2 billion, a 21 percent jump from the $5.7 billion appropriated last year


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WHAT ARE WE DOING


$485,000 for a boarding school for at-risk native students in western Alaska

$1.2 million for Helen Keller International so the nonprofit organization can provide eyeglasses to students with poor vision

Dozens of state and local government money awards for police equipment and to combat methamphetamine


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$2.4 billion a 13% increase for the Agriculture Department

10% increase for the money-losing Amtrak passenger rail system


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WHAT ARE WE DOING


Congress increased its own budget by 10%, bringing it to $4.4 billion

Provision denying lawmakers the automatic cost-of-living pay increase they are due January 1, 2010


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How did the recent decrease in household wealth, net exports, and

business investment affect aggregate demand?

What effects should expect from the Tarp Act, the American Recovery and

Reinvestment Act, and the $410B spending bill on aggregate demand?


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Keynesian Multiplier Principle

Concept: In the short run, for every dollarof increased government spending, real GDP/real Income will increase by a multiplied amount

How would this occur?


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Fiscal policy pursued by FDR to get us out of the Great Depression from John Maynard Keynes in the General Theory of Employment, Interest and Money written in 1936

GDP contracted nearly 30%

Unemployment rose to about 25%

Did it work? Yes and No


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By 1938, 6 million of the 14 million unemployed were back at work

During the Great Depression, government spending, which at time represented about 10% of GDP, increased to establish many new programs for job creation and to put people back to work


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What actually ended the Great Depression?


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From 1939 to 1944, real GDP almost doubled and unemployment fell

from 17% to 1%


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US government at all levels was about 10% of GDP prior to the Great Depression

Percent rose after the Great Depression

What is the size of US government in recent years?


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Federal Government averages about 20% of GDP

State and Local governments average about 15% of GDP


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NOTA BENE (N.B.): Economists do not always agree

Value of the multiplier is a source of disagreement and is particularly

important given the magnitude of the current government fiscal policies


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Robert J. Barro, Harvard economics professor and senior fellow at Stanford’s Hoover Institution, on January 22, 2009 in “Government Spending is No Free Lunch” discussed the multiplier:

First assume that the multiplier was 1.0 … an increase of one unit in government purchases … would lead to an increase by one unit in real GDP. If the government buys another airplane or bridge, the economy’s total output expands by enough to create the airplane or bridge without requiring a cut in anyone’s consumption or investment.


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If the multiplier is greater than 1.0 … the process is even more wonderful … real GDP

rises by more than the increase in government purchases.

Barro estimated a war-time multiplier of 0.8 based on spending from 1943-1944


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The war-based multiplier of 0.8 substantially overstates the multiplier that applies to

peacetime government purchases … when I attempted to estimate directly the multiplier

associated with peacetime government purchases, I got a number insignificantly

different from zero.


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Obama’s economic advisers are assuming multiplier of 1.5

Robert J. Barro and other economists believe that the multiplier is significantly less than

one or about one and that we are invalidating “everything we learned about macroeconomics since 1936”


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WHAT ARE WE DOING

BAILOUTS

Freddie Mac and Fannie Mae – Amount ?

Conservatorship

US Government controlled under the Federal Housing Finance Agency


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BAILOUTS

AIG – $182B to date

Partially owned by the US Government

Paid out more than $160M in bonuses with 73 employees getting $1 million or more


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BAILOUTS

14 Banks sold stock to US Treasury $192 million

Alpine Banks of Colorado $70 million

Trinity Capital Corp (New Mexico) $35 million

Spirit Bankcorp (Oklahoma) $30 million

CBS Banc-Corp (Alabama) $24.3 million

MS Financial Inc (Texas) $7.7 million

Naples Bancorp (Florida) $4 million


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WHAT ARE WE DOING

BAILOUTS

SBT Bancorp (Connecticut) $4 million

Pathway Bancorp (Nebraska) $4 million

Triad Bancorp (Montana) $4 million

Clover Community (So. Carolina) $3 million

CSRA Bancorp (Georgia) $2.5 million

IBT Bankcorp (Texas) $2.3 million

Maryland Financial (Maryland) $1.7 million

Colonial American Bank (Pennsylvania) $ .6 million


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BAILOUTS

Is this all of the banks that have received aid from the US

government?


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BAILOUTS

No, this is some of the small bailouts

Union First Market Bank (Virginia) sold $59 million in stock to the US Treasury


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BAILOUTS

And there are the credit unions …..

US Central Corporate Federal Credit Union and Western Corporate

Federal Credit Union are in conservatorship with $57B in assets


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BAILOUTS

Good News!

Some large and small banks planning to repay or return

bailout money


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BAILOUTS

Bad News!

US Treasury March 23, 2009 announced it will buy up to $1 trillion

in “toxic assets” through partnerships with private investors

PUBLIC-PRIVATE INVESTMENT PROGRAM (PPIP)

http://www.treas.gov/press/releases/reports/ppip_fact_sheet.pdf


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WHAT ARE WE DOING

BAILOUTS

PPIP Provisions

FDIC will create investment pools of toxic assets

Auction the investment pools

US Treasury will partner with the auction winners form public-private partnerships


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WHAT ARE WE DOING

BAILOUTSPPIP Provisions

US Treasury example used a 6 to 1 debt equity ratio:

Asset pool face value $100 sells for $84FDIC would provide a financing guaranty for

$72 of the debtInvestor and US Treasury each pay $6 to

create $12 in equity for the $84 debt


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WHAT ARE WE DOING

BAILOUTSPPIP Provisions

Private investor would service the loans using an asset manager with the responsibility of oversight who has been approved from the FDIC

How much would the private investor have at risk?


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BAILOUTS

PPIP Provisions

For MBS (mortgage backed securities) US Treasury will hire 5 asset managers who will seek private investors

US Treasury will match equity for every dollar raised from investors


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WHAT ARE WE DOING

BAILOUTS

PPIP Provisions

Asset managers can get additional debt financing up to 50% of the equity in the asset pool

US Treasury said in some cases, it might provide financing of up to 100% of the equity


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BAILOUTS

PPIP Provisions

Asset managers would have complete discretion over the asset pools

How much would an investor have at risk if they are able to finance 100% of their equity purchase?


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BAILOUTS

RETURN TO TARP -- Mortgage Goals

Keep people in their homes

Lower the default/foreclosure rates

Allow banks and mortgage lenders to stay in business


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BAILOUTS

TARP Mortgage Provisions

Cheaper fixed rates loans if lenders agree to take losses on their loans

Mortgage could only represent 90% of the property value

Avoid foreclosure, eliminate negative equity


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BAILOUTSTARP Mortgage Provisions

Mortgages up to $625,500

Borrowers penalized if they re-fi or sell during the next 5 years

$7,500 tax credit if single earning <$75,000 or married <$150,000 a year—to be repaid interest free over 15 years


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BAILOUTS

TARP Mortgage Goals

Must live in the home

Mortgage signed before January 1, 2008

Mortgage payments must exceed your Gross Annual Income by 31%


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BAILOUTS

$75B MAKING HOME AFFORDABLE

Two separate programs:

Home Loan Refinance

Home Loan Modification


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WHAT ARE WE DOING

BAILOUTSLOAN REFINANCE PROGRAM

Available to 4 to 5 million homeowners with good payment history on an existing mortgage owned by Fannie Mae or Freddie Mac

Normally, these borrowers would be unable to refinance because their homes have lost value, pushing their current loan-to-value ratios above 80 percent


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WHAT ARE WE DOING

BAILOUTSLOAN REFINANCE PROGRAM

Eligibility requirements:

Owner and occupant of a one- to four-unit home

Your property loan is owned/secured by Fannie Mae or Freddie Mac

At the time you apply, you must be current on your mortgage payments (meaning you have not been more than 30 days late in the last 12 months)


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BAILOUTS

LOAN REFINANCE PROGRAM

Must have sufficient income to support the new mortgage payments

Owners can refinance up to 105 percent of the new value of the home

This program will end in June 2010


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BAILOUTSLOAN REFINANCE PROGRAM EFFECTS

Reduce mortgage payments

Borrowers paying interest-only payments or those who have a low introductory rate that will increase in the future may not see their current payment go down, but they could save a great deal over the life of the loan by avoiding future mortgage payment increases

Refinancing will not reduce the amount that borrowers will owe on the loan, but helps borrowers get into more affordable loans


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BAILOUTSLOAN MODIFICATION PROGRAM

Help 3 to 4 million at-risk homeowners

Reduce monthly mortgage payments to no more than 31 percent of the borrower's gross monthly income


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Working with the banking and credit union regulators, the FHA, the VA, the USDA and the Federal Housing Finance Agency, to pursue affordable and sustainable mortgage modifications


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Banks and other mortgage providers can begin immediately to modify eligible mortgages under the modification program so that at-risk borrowers can better afford their payments


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BAILOUTSLOAN MODIFICATION PLAN

Eligibility requirements are as follows:

Mortgage loan must have originated before January 1, 2009

Must be first-lien loans on owner-occupied properties with unpaid principal balance up to $729,750


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Loan limits above $729,750 are allowed for owner-occupied properties with two to four units

Mortgage payment (including taxes, insurance, and homeowners association dues) must be more than 31 percent of your gross monthly income


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WHAT ARE WE DOING

BAILOUTS

LOAN MODIFICATION PLAN

All borrowers must fully document income, including a signed IRS 4506-T, two most-recent pay stubs, most recent tax return, and must sign an affidavit of financial hardship


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Property owner occupancy status will be verified through borrower credit report and other documentation

Modifications can start from now until Dec,

21, 2012 with loans only modified once under the program


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New FHA Streamline Refinance Program

Homeowners who have been on time since they took out their FHA mortgage qualify in a simple process takes about a week

It allows people to skip up to two months of mortgage payments and can drastically reduce their monthly payment


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WHAT ARE WE DOING


New FHA Streamline Refinance Program

Borrowers with an FHA loan may simply modify their interest rate and monthly payment with no credit check and no income verification

Those who currently do not have an FHA loan can still take advantage of the extremely low interest rates and convert their loan to an FHA loan


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MONETARY POLICY

Fed maintaining low interest rate target, close to zero, for the Federal Funds rate of interest – bank to bank loan interest rate

Fed buying long term US Treasury Bonds and billions in MBS (mortgage backed securities)

Treasury Bonds - IOUs of the US Government


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MONETARY POLICY

Buying Treasury Bonds increases the demand for bonds, raises their price and lowers their yield

March 2009 Fed buying caused bond yields to fall to about 2.5% and 30 year fixed mortgage rates fell to about 4.7% interest


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WHAT ARE WE DOING

MONETARY POLICY

Fed may increase the money supply up to $1.15T:

Buying $300B in US Treasury Bonds

Raise the amount of MBS of Fannie Mae and Freddie Mac that may be purchased from $500B to $1.25T

Potential additional purchases of US Treasury Bonds of $100B


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MONETARY POLICY

Fed has been successful providing downward pressure

to keep interest long term interest rates low


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Fiscal Policy √

Monetary Policy √

Legislative Summaries √

Bush Tax Rebate 2008 √

Obama Tax Credit √

TARP (Troubled Asset Relief Program) √

American Recovery and Reinvestment Act √

$410B Bill to Fund Federal Government √

Making Home Affordable Program √

Keynesian Multiplier Principle √

Bailouts √


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WHAT IS GOING ON √

HOW DID WE GET HERE √

WHAT ARE WE DOING √

COST/BENEFIT ANALYSIS OF CHOICES

Documents

Principles of Macroeconomics