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Principles of Macroeconomics 73103
L ECTURE 5: C REDIT M ARKETS
Chris Sleet
Outline
1
Introduction and Basic Definitions
2
Demand and Supply of Financial Assets
First look at what motivates people to borrow and lend
3
Financial System (as a whole)
4
Credit Supply & Demand Model
5
Banks
Slide 2 of 57
C REDIT M ARKETS I NTRODUCTION
Slide 3 of 57
Assets
Asset: object that gives owner a stream of future income or services
1
Real assets: A physical object that generates income or services
Examples:
Physical capital (output for the owner)
Human capital (labor income for the owner)
House (shelter services for the owner)
2
Financial assets: promise made by seller to pay income to buyer in future
Examples:
Bonds
Shares of companies (i.e. stocks)
Slide 4 of 57
Financial Assets
We will mainly be interested in financial assets in this lecture
Slide 5 of 57
Financial Assets
We will mainly be interested in financial assets in this lecture
Different names: securities, claims
Slide 5 of 57
Financial Assets
We will mainly be interested in financial assets in this lecture
Different names: securities, claims
Since these are promises, they are:
assets for buyer (who will get promised payments)
Slide 5 of 57
Financial Assets
We will mainly be interested in financial assets in this lecture
Different names: securities, claims
Since these are promises, they are:
assets for buyer (who will get promised payments)
liabilities for issuer or seller (who will make promised payments)
Slide 5 of 57
Financial Assets
We will mainly be interested in financial assets in this lecture
Different names: securities, claims
Since these are promises, they are:
assets for buyer (who will get promised payments)
liabilities for issuer or seller (who will make promised payments)
Many types of financial asset:
Slide 5 of 57
Financial Assets
We will mainly be interested in financial assets in this lecture
Different names: securities, claims
Since these are promises, they are:
assets for buyer (who will get promised payments)
liabilities for issuer or seller (who will make promised payments)
Many types of financial asset:
Differ in amount, timing, conditions of payment to owner
Slide 5 of 57
Financial Assets: Examples
Money: medium of exchange used to make transactionsmore in Lec. 6!
Financial Assets: Examples
Money: medium of exchange used to make transactionsmore in Lec. 6!
Debt: Claim to given payment stream, often secured on other assets
+ Bank loan, Corporate bond, Treasury bond, Treasury bill
Financial Assets: Examples
Money: medium of exchange used to make transactionsmore in Lec. 6!
Debt: Claim to given payment stream, often secured on other assets
+ Bank loan, Corporate bond, Treasury bond, Treasury bill
Equity: Residual claim to income from real or financial assets, usually of a
corporation & coupled with corporate control
+ Shares
Financial Assets: Examples
Money: medium of exchange used to make transactionsmore in Lec. 6!
Debt: Claim to given payment stream, often secured on other assets
+ Bank loan, Corporate bond, Treasury bond, Treasury bill
Equity: Residual claim to income from real or financial assets, usually of a
corporation & coupled with corporate control
+ Shares
Derivative: Claim with payoff dependent on value of another (usually
financial) asset
+ Forward contracts, options, swaps
Characteristics of Assets
Liquidity: Speed (and price impact) with which asset can be traded for goods
or other assets
+ Money is liquid, Local government debt is not
Slide 7 of 57
Characteristics of Assets
Liquidity: Speed (and price impact) with which asset can be traded for goods
or other assets
+ Money is liquid, Local government debt is not
Maturity: Date at which asset ceases to make payments
+ US Treasury bills are short term; Shares have no maturity date
Slide 7 of 57
Characteristics of Assets
Liquidity: Speed (and price impact) with which asset can be traded for goods
or other assets
+ Money is liquid, Local government debt is not
Maturity: Date at which asset ceases to make payments
+ US Treasury bills are short term; Shares have no maturity date
Risk: Uncertainty over payment
+ US Treasury bills have little risk; Shares carry more risk
Slide 7 of 57
Buyers and Sellers
Buyers and sellers of financial assets are also known as:
Buyer of financial asset: Saver, lender, creditor, supplier of credit
Seller of financial asset: Borrower, demander of credit, dissaver
Slide 8 of 57
D EMAND
Slide 9 of 57
AND
S UPPLY
OF
F INANCIAL M ARKET A SSETS
Why Buy or Sell a Financial Asset?
Financial asset costs up front, pays out later in some situations
Allows buyer to transfer income from time of purchase to some later date
If risky, allows buyer to transfer income across states of world
Why would you do this? Allows buyer to transfer income from states where she
values income less to those in which she values income more
Slide 10 of 57
Why Buy or Sell a Financial Asset?
Financial asset allows seller to raise funds to purchase a real asset that pays
out in the future
e.g. a college degree, new capital, the salaries of the creative team in a start up
Slide 11 of 57
Consumption Smoothing
Most peoples labor earnings have a
distinctive lifecycle profile
First increases as they acquire
experience & skills
Then stabilizes; Falls after
retirement
But people try & smooth their
consumption
To smooth consumption, they first
borrow, then save and finally dissave
Slide 12 of 57
A Consumption Choice Problem
Suppose Ms X lives for two periods called Work and Retirement
She earns $100 during the work period & $0 during retirement
+ What does this imply about Ms.Xs income stream?
Let Cwork = how much she consumes during work period; Cretire = how much
she consumes during retirement
Her budget constraint is 100 = Cwork + Cretire
+ Interpret!!
Slide 13 of 57
A Consumption Choice Problem
If she consumes Cwork and Cretire she derives utility (happiness) of:
Utility =
p
Cwork +
p
Cretire
What should she do? How should she split her income across periods?
Slide 14 of 57
A Consumption Choice Problem
Result: Utility maximized when
consumption smoothed (split evenly)
across periods
A Consumption Choice Problem
Result: Utility maximized when
consumption smoothed (split evenly)
across periods
Check the numbers: Ü Ü
Cwork
100
90
80
70
60
50
40
30
20
10
0
Cretire
0
10
20
30
40
50
60
70
80
90
100
Utility
10.00
12.65
13.42
13.84
14.07
14.14
14.07
13.84
13.42
12.65
10.00
A Consumption Choice Problem
Result: Utility maximized when
consumption smoothed (split evenly)
across periods
Check the numbers: Ü Ü
Why?
Our utility
utility
?
c implies Diminishing marginal
Implies Ms X prefers not to concentrate
consumption
Cwork
100
90
80
70
60
50
40
30
20
10
0
Cretire
0
10
20
30
40
50
60
70
80
90
100
Utility
10.00
12.65
13.42
13.84
14.07
14.14
14.07
13.84
13.42
12.65
10.00
A Consumption Choice Problem
10
Utility
8
6
4
2
0
0
20
Plot shows utility in each period
40
60
80
Consumption
100
A Consumption Choice Problem
10
Utility
8
6
4
2
0
0
20
40
60
80
Consumption
First consider Cwork = 20 & Cretire = 80
100
A Consumption Choice Problem
10
Utility
8
6
4
2
0
0
20
40
60
80
Consumption
100
Raise Cwork from 20 to 40: how much utility does Ms X gain?
A Consumption Choice Problem
10
Utility
8
6
4
2
0
0
20
40
60
80
Consumption
100
Raise Cwork from 20 to 40: how much utility does Ms X gain?
(To pay for this) lower Cretire from 80 to 60: how much utility does she lose?
A Consumption Choice Problem
10
Utility
8
6
4
2
0
0
20
40
60
80
Consumption
100
Raise Cwork from 20 to 40: how much utility does Ms X gain?
(To pay for this) lower Cretire from 80 to 60: how much utility does she lose?
Overall is she better or worse off?
Budgets and Saving
Before: 100 = Cwork + Cretire
Break this single budget constraint down into two budget constraint:
S
Consume/Save when working : 100 = Cwork + |{z}
saving
Consume when retired :
S = Cretire
Perfect consumption smoothing: Cwork = 50 and Cretire = 50 =? S = 50
Slide 17 of 57
Budgets and Saving with Interest
Budget constraints with interest:
Consume/Save when working : 100 = Cwork + S
Consume when retired :
where r is interest
Slide 18 of 57
(1 + r)S = Cretire
Budgets and Saving with Interest
Put these two budget constraints together (i.e. substitute out for savings):
100 = Cwork + S
and
S=
Cretire
1
=? 100 = Cwork +
Cretire
1+r
1+r
Price of consumption when working is 1 and in retirement is
1
1+r
Interest makes consumption later (in retirement) cheaper & encourages
saving!
Slide 19 of 57
Why Buy or Sell Financial Assets?
Desire to consumption smooth encourages:
Young to borrow (or sell financial assets)
Working middle aged to save (buy financial assets)
Retired old to dissave (sell off financial assets)
Interest payments encourage saving & damp down consumption smoothing
Slide 20 of 57
Why Buy or Sell Financial Assets?
So far, variation on income due to age
People also dislike variation in income due to luck:
Its 2019 and I lose my job vs. its 2019 and I get a promotion
We call this risk aversion
People try & smooth consumption across good & bad income states of the
world through insurance or savings
Slide 21 of 57
Why Buy or Sell Financial Assets?
Summary so far:
+ People who expect higher future income borrow, e.g. young
+ People who expect low future income save, e.g. middle aged
+ People who expect uncertain future save (more), e.g. those anticipating
economic downturn
+ Higher returns on saving matter by affecting price of consumption over periods
E.g. higher interest rate or tax incentives for savings will raise savings
People also borrow to finance purchase of a real asset that delivers future
flow of income (e.g. a college degree) or a future flow of services (e.g. a house)
Slide 22 of 57
Why Buy or Sell Financial Assets?
Firms borrow to finance purchase of a real asset (investment)
Can analyze investment decision by firms similar to our analysis of employment
decisions by firms
Slide 23 of 57
Why Buy or Sell Financial Assets?
Firms borrow to finance purchase of a real asset (investment)
Can analyze investment decision by firms similar to our analysis of employment
decisions by firms
Governments borrow to finance expenditure:
Tax smooth over wars
Finance a real asset with a future payoff (education)
Helping some people consumption smooth
Slide 23 of 57
T HE F INANCIAL S YSTEM
Slide 24 of 57
Functions of Financial System
Improve allocation of capital: transfer capital from savers (investors) to
capital users (usually corporations)
+ Example: A person allocates pension savings to a new issue of stock, and
company management uses proceeds of new issue to buy capital
Improve allocation of risk: Risk transfer, sharing, and management;
reduction of risk-bearing by repackaging risks
Consumption timing: allow people to smooth consumption intertemporally
+ Example: A student has low income now but high future income; a student loan
allows student to smooth her consumption through time relative to her income
through time
Slide 25 of 57
Financial Markets
Primary vs. Secondary Markets
Primary Market: markets for new issues of securities (e.g. initial public offering
(IPO) of equity by privately-held firm)
Secondary Market: markets in which previously issued securities traded
Slide 26 of 57
Financial Markets
Primary vs. Secondary Markets
Primary Market: markets for new issues of securities (e.g. initial public offering
(IPO) of equity by privately-held firm)
Secondary Market: markets in which previously issued securities traded
Market Trading Arrangements
Direct search: Buyers & sellers find each other directly, without intermediaries
(e.g. used cars)
Brokered markets: Buyers & sellers rely on intermediaries to find each other
(e.g. residential real estate)
Dealer markets: Buyers & sellers trade with intermediaries who maintain
inventories and are willing to buy and sell when a customer demands it
Auction markets: Centralized location where buyers and sellers interact directly
with each other and dealer presence is minimal
Slide 26 of 57
Financial Markets
Exchange vs. Over-the-Counter Market
Exchange: Buyers & sellers of securities meet in a central location to trade
Over-the Counter Market: Dealers at different locations stand ready to buy and
sell securities over the counter to anyone that accepts their prices
Examples: NYSE (stocks); Chicago Board of Trade (futures)
Banks
Savers and Borrowers trade with intermediary (bank)
Bank actively seeks out and evaluates borrowers
Bank combines bank deposits and bank equity and uses them to make loans
Slide 27 of 57
A C REDIT M ARKET M ODEL
Slide 28 of 57
Credit Markets
Will now build a very simple model of the financial system
Will call this a credit market model
Slide 29 of 57
The Simplest Credit Market
Savers lend for one period of time & receive repayment with interest
No uncertainty about repayment
Single repayment
Nominal Interest rate is rate paid per $1 loan
Lend $ 1 & Repay $1.25 Ü Interest rate: 0.25 or 25%
Lend $ L & Repay $(1+i)L Ü Interest rate: i or i × 100%
Slide 30 of 57
Nominal vs. Real Interest Rates
Nominal interest rates, i
Future $ repayment on a $1
No adjustment for inflation
Real interest rates, r
Adjusted for inflation, ?
Future repayment on a $1 expressed in todays $s
Fisher equation:
r =i ??
Slide 31 of 57
Credit Demand Curve
Real Interest Rate
10
9
8
7
6
5
4
3
2
Credit
Demand Curve
1
20
40
60
80
Why does this slope downwards?
Slide 32 of 57
100 120 140 160 180
Quantity of Credit
Credit Demand Curve
Real Interest Rate
Real Interest Rate
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
Credit
Demand Curve
1
20
40
60
80
100 120 140 160 180
1
Quantity of Credit
20
40
A Flat Demand Curve
What does the slope of the demand curve signify?
Slide 33 of 57
60
80
Credit
Demand Curve
Quantity of Credit
100 120 140 160 180
A Steep Demand Curve
Credit Demand Curve
Real Interest Rate
10
9
8
7
6
5
4
3
Left shift of Credit
Demand Curve
2
1
Right shift of Credit
Demand Curve
Quantity of Credit
20
40
60
80
100 120 140 160 180
What happens if:
Firms anticipate higher future productivity?
US Federal government runs a higher deficit?
Households buy the new iPhone?
Slide 34 of 57
Credit Supply Curve
Real Interest Rate
Credit
Supply Curve
10
9
8
7
6
5
4
3
2
1
Quantity of Credit
20
40
60
80
100 120 140 160 180
Why does this slope upwards? Why might it not?
Workers become nervous about future job prospects?
Slide 35 of 57
Credit Market Equilibrium
Real Interest Rate
Credit
Supply Curve
10
9
8
7
6
5
r?
4
3
2
1
Q?
20
Slide 36 of 57
40
60
80
Credit
Demand Curve
100 120 140 160 180
Quantity of Credit
Credit Market Equilibrium: An Increase in the Federal Deficit
Real Interest Rate
Credit
Supply Curve
10
9
8
7
6
5
4
r ??
r?
3
Credit
Demand Curve
2
1
Q?
20
Slide 37 of 57
40
60
80
Q ??
100 120 140 160 180
Quantity of Credit
B ANKS
Slide 38 of 57
Banks
Slide 39 of 57
Banks and their Balance Sheets
Banks are examples of financial intermediaries
Financial intermediation:
Borrowing from savers
Lending to borrowers
A (bank) balance sheet lists what is owned (assets) and what is owed
(liabilities)
Slide 40 of 57
Assets
Bank reserves: vault cash & holdings on deposit at the Federal Reserve Bank
Cash Equivalents: low risk, liquid assets that a bank can easily sell
Long-term Investments: risky, illiquid assets including loans to households
and firms and the value of bankO?s properties
Slide 41 of 57
Liabilities
Demand deposits: funds that depositors can access on demand
Short-term borrowing: loans from other financial institutions that are short
in duration
Long-term borrowing: debt that is due to be repaid in one year or more
Slide 42 of 57
Equity
Stock-holders equity = Banks total assets -Banks total liabilities
Book value of the bank
Estimated value of bank if priced correctly by stock market
Slide 43 of 57
Banks
Slide 44 of 57
1
1
Bank Balances Sheets in U.S. Data
Ratio of Short-Term Debt to Total Assets
.1 .2 .3 .4 .5 .6 .7 .8 .9
Ratio of Short-Term Debt to Total Assets
.1 .2 .3 .4 .5 .6 .7 .8 .9
P90
P50
P90
P50
P10
0
0
P10
1970
1975
1980
1985
1990
1995
2000
2005
2010
Percentiles of Short-Term Debt to Total Assets, US Financial Firms
2015
1970
1975
1980
1985
1990
1995
2000
2005
2010
Percentiles of Short-Term Debt to Total Assets, US Non-Financial Firms
2015
Distribution of Short-Term Debt Issuance by Banks and other Financial Institutions and
by Non-financial firms in the U.S.
Typical bank uses a lot of short-term liabilities to pay for its assets
Typical non-bank firm does not!
Slide 45 of 57
Ratio of Short-Term Debt to Short-Term Assets
.5
1
1.5
2
2.5
3
Ratio of Short-Term Debt to Short-Term Assets
.5
1
1.5
2
2.5
3
Bank Balances Sheets in U.S. Data
P90
P50
P10
0
P50
0
P10
P90
1970
1975
1980
1985
1990
1995
2000
2005
2010
Percentiles of Short-Term Debt to Short-Term Assets, US Financial Firms
2015
1970
1975
1980
1985
1990
1995
2000
2005
2010
Percentiles of Short-Term Debt to Short-Term Assets, US Non-Financial Firms
2015
Distribution of Short-Term Debt Issuance by Banks and other Financial Institutions and
by Non-financial firms in the U.S.
Typical bank has more short-term debt than cash
Typical non-bank firm does not!
Slide 46 of 57
What Banks Do
Banks perform three interrelated functions as financial intermediaries:
1
Transform long-term investments into short-term liabilities
+ Maturity Transformation
2
Transform high risk assets into low risk liabilities
+ Risk Transformation
3
Identify profitable lending opportunities
Slide 47 of 57
Managing Risk
To transform high risk loans into low risk bank deposits, banks:
1
Hold diversified portfolio of assets (risky loans)
Less likely all assets will underperform at same time
2
Transfer risk to shareholders
Shareholders absorb falls in value of overall asset portfolio
3
Transfer risk to US government & tax payers if bank driven into insolvency
during financial crisis
Depositors insured up to $250 K by FDIC
FDIC can close failing bank and payoff depositors or organize purchase of bank
by another bank
Slide 48 of 57
Risk in Banks
+ Two types of risk:
1
Large fraction of assets underperform
Source: Risky assets on balance sheet
2
Large fraction of depositors withdraw at same time
Source: Maturity mismatch
Banks hold many illiquid assets
And many liquid liabilities
Slide 49 of 57
A Bank Run
Every day some depositors deposit, others withdraw
Reserves act as the buffer
+ In a bank run:
Many depositors run & try to withdraw at same time
Banks reserves are exhausted
Bank must obtain funds quickly from elsewhere
Worst case: liquidate loans (fire sale) at a loss
May force bank into insolvency
Fear of this may encourage run in first place!
Many bank runs Ü bank panic
Slide 50 of 57
Ending Bank Runs?
Historically, bank runs a major problem in US
Large scale bank panic occurred in 1932/3
Two policy responses:
Discount window: backstop liquidity
Federal Deposit Insurance: credit put to depositors
Slide 51 of 57
Ending Bank Runs?
2008news that the bank had approached the government for support
Within 24 hours, people rushed to withdraw their savings
Northern Rock first British bank in 150 years to fail due to a bank run
Slide 52 of 57
Figure 1
Bank Panics: Past and Present
Proportion of Countries with Banking Crises, 1900-2008
Weighted by Their Share of World Income
The Great
Depression
45
The First Global Financial Crisis of 21st
Century
40
35
Emerging Markets, Japan the
Nordic Countries, and US(S&L)
Percent of counties
30
World War I
25
20
The Panic
of 1907
15
10
5
2008
2005
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
1936
1933
1930
1927
1924
1921
1918
1915
1912
1909
1906
1903
1900
0
Fraction of Countries
with Banking Crises, 1900-2008; Fraction of 66 independent
Sources: Bordo et al. (2001), Caprio et al. (2005), Kaminsky and Reinhart (1999), Jácome (2008), Maddison (2003),
additional sources
in Appendix II, share
which provides
dates.
country-statesand
weighted
bylisted
countrys
of banking
worldcrises
income;
from Reinhart and Rogoff
Notes: Sample size includes all 66 countries listed in TableA1 that were independent states in the given year. Three
sets
of
GDP
weights
are
used,
1913
weights
for
the
period
18001913,
1990
for
the
period
19141990, and finally
(2008).
2003 weights for the period 19912006. The entries for 20072008 list crises in Austria, Belgium, Germany,
Hungary, Japan, the Netherlands, Spain, the United Kingdom, and the United States. The figure shows a three-year
moving average.
It is no surprise that the worldwide Great Depression of the 1930s posts the highest
Slide 53 of 57
Bank Panics: Macro Consequences
470
MAY 2009
AEA PAPERS AND PROCEEDINGS
Spain, 1977
1
Japan, 1992
2
Norway, 1987
3
Banking crises
Philippines, 1997 4
Sweden, 1991
associated with large
declines in GDP per
capita
5
Hong Kong, 1997 6
Colombia, 1998
7
Korea, 1997
8
Historical average9
9.3 percent
Malaysia, 1997
10
Finland, 1991
11
Thailand, 1997
Indonesia, 1997
Argentina, 2001
US, 1929
30
25
20
15
10
5
0
Percent decrease
5
1.9 years
Declines feature short
duration (less than 2
years)
12
13
14
15
0
1
2
3
4
Duration in years
5
Figure 4. Past Real Per Capita GDP Cycles and Banking Crises:
Peak-to-Trough Decline in Real GDP (left panel) and Years Duration of Downturn (right panel)
Past Real
GDP
Cycles
and
Crises:
Notes: Eachper
banking Capita
crisis episode is identified
by country
and the beginning
year of Banking
the crisis. Only major (systemic)
banking crisis episodes are included, subject to data limitations. The historical average reported does not include ongoing crisis
episodes. Total GDP, in millions of 1990 US$ (converted at Geary Khamis PPPs) divided by midyear population.
Peak-to-Trough
Decline in Real GDP (left panel) and
Sources: Total Economy Database (TED), Historical Statistics of the United States (HSOUS), and authors calculations.
Duration of Downturn in Years (right panel); from
Figure
4 looks Rogoff
at the cycles in(2009)
real per capita
Compared to unemployment, the cycle from
Reinhart
and
GDP around banking crises. The average magpeak to trough in GDP is much shorter, only two
nitude of the decline, at 9.3 percent, is stunning. Admittedly, for the postWorld War II
the declines in real GDP are smaller for
Slide 54period,
of 57
advanced economies than for emerging market
years. Presumably, this is partly because potential GDP growth is positive, and we are measuring only absolute changes in income, not gaps
relative to potential output. Even so, the reces-
Bank Panics: Macro Consequences
THE AFTERMATH OF FINANCIAL CRISES
VOL. 99 NO. 2
Malaysia, 1997
7 percent
0
5
10
469
15
Indonesia, 1997
14
Japan, 1992
13
Thailand, 1997
12
Philippines, 1997
11
Hong Kong, 1997
10
Norway, 1987
9
Korea, 1997
8
Argentina, 2001
7
Banking crises
associated with large
increases in
unemployment
4.8 years
Historical average 6
15
20
Percent increase
25
Sweden, 1991
5
Spain, 1977
4
Colombia, 1998
3
Finland, 1991
2
US, 1929
1
Labor market
downturns feature long
durations
0
2
4
6
8
10
12
Duration in years
Figure 3. Past Unemployment Cycles and Banking Crises: Trough-to-Peak
Percent Increase in the Unemployment Rate (left panel) and Years Duration of Downturn (right panel)
Past Unemployment
Cycles
Banking
Notes: Each banking crisis episode is identified
by countryand
and the beginning
year of the crisis.Crises:
Only major (systemic) banking crisis episodes are included, subject to data limitations. The historical average reported does not include ongoing crisis
episodes.
Trough-to-Peak Unemployment Rise (left panel) and
Sources: OECD, IMF, Historical Statistics of the United States (HSOUS), various country sources, and authors
calculations.
Duration
of Downturn in Years (right panel); from
Reinhart and Rogoff (2009)
Figure 3 looks at increases in unemployment
rates across the historical comparison group. (As
the
rate is classified as a lagging
Slide 55 ofunemployment
57
indicator, we do not include the current crisis.)
economies. While there are well-known data
issues in comparing unemployment rates across
countries,3 the relatively poor performance in
advanced countries suggests the possibility that
Appendix: The Crisis
Credit boom prior to 2007: Steeply rising house prices
Partly underpinned by rise of shadow banking
Banks (and other loan originators) sold risky mortgages onto shadow banks
Shadows repackaged them as short maturity asset backed securities (ABS) and
sold them on
Economic situation of 2007/8 caused greater numbers of defaults by sub-prime
lenders
Panic in shadow banking: shadow banks cannot refinance (i.e. sell new ABS to
meet value of maturing ABS)
Slide 56 of 57
Appendix: The Crisis
Run infects major commercial banks that sponsored shadow banking
institutions
Early 2008Fed acts to promote liquidity; organize JP Morgan Chases
takeover of Bear Stearns
September 15, 2008Lehmann Bros. files for bankruptcy.
September 16, 2008Run on MMMFs begins.
Fed implements: liability guarantees, asset purchases (TARP),
recapitalization (stock purchases), Quantitative Easing
Afterwards, bank capital destroyed
Banks hesitant to lend
Slide 57 of 57
73-103 Principles of Macroeconomics Fall 2021
First Name:
Last Name:
Andrew ID:
Recitation Section:
Homework #3
Release: Sunday, October 24, 2021
Submit by: WEDNESDAY November 3, 2021
Submit a scan (or photograph) of your completed assignment through Gradescope by 5pm on
Wednesday, November 3rd, 2021. To ensure all students have the same time, the 5pm deadline is
STRICTLY enforced. Late homework is not accepted.
If you have access to a printer, please print this problem set and answer in the spaces provided.
You do NOT need to submit any pages that are just instructions. Alternatively, type solutions in
a file or write neatly by hand and photograph.
Write neatly.
Answer the questions clearly and completely. Read instructions carefully.
Show all calculations. We can then give you partial credit if you make a mistake. In
questions, where an explanation is asked for, we are targeting an explanation or idea
that was mentioned in class. Your answer should target this too!
This homework consists of three parts. These will consolidate your knowledge of labor markets
from Lecture 4 and weeks 9 and 10 of the course. In part A you are asked to describe the state of
the U.S. Labor market in October. In part B, you will use the labor supply and demand model to
determine the effects of minimum wage policy. In part C, you will work with U.S. data to learn
about measures of employment.
This version: Fall 2021
1
© Prof. Chris Sleet
73-103 Principles of Macroeconomics Fall 2021
A. (10 points) The Current State of the U.S. Labor Market
At the end of this assignment, I have attached a three page summary release from the Bureau
of Labor Statistics describing the current state of the U.S. Economy (from October 8, 2021).
In the space provided below give your own summary. Be sure to summarize the current state
of employment, the unemployment rate and the labor force participation rate. Based on these
numbers offer a view of whether the U.S. labor market is strong or weak. Discuss at least one
additional piece of information you would like to know (that is not provided in this release)
that would help you arrive at a conclusion about the health of U.S. labor markets.
Answer:
73-103 Principles of Macroeconomics Fall 2021
B. (25 points) What is the right measure of employment?
There are two ways to measure employment. The first is to ask people whether they are
employed or not. The second is to ask firms how many people they are employing. In the US,
the Bureau of Labor Statistics does both via a household survey (which surveys people) and
an establishment survey (which surveys firms).
On October 4, 2019, the Bureau of Labor Statistics released the September 2019 Jobs Report.
The household survey indicated employment had risen by 319,000. The establishment survey
indicated that non-farm payroll employment had risen by 136,000. Thats a difference of
roughly 200,000 jobs! This question asks you to study these discrepancies systematically by
obtaining data on these two different series. You should also briefly skim this note from the
Bureau of Labor Statistics:
https://www.bls.gov/news.release/empsit.tn.htm
Go online and navigate to the FRED® website (https://fred.stlouisfed.org/).
Find the data series with the mnemonic codes, CE16OV and PAYEMS (you do locate
these by searching for them in the search bar. Or, you could find them by clicking on
Category and browsing first under Current Population Survey (Household Survey)
and then by Current Employment Statistics (Establishment Survey). For each series,
do the following:
Click on the series. FRED® should open an up-to-date line graph with your data.
Click on Download (on the far right).1
After downloading and opening both files, copy the data for CE16OV into the worksheet
for the data for PAYEMS. Be careful lining up the dates! (Note that establishment survey data start earlier, which is why we are adding the household data to the establishment
data worksheet.)
1
If youre having trouble, review the more detailed instructions to download data from HW1.
73-103 Principles of Macroeconomics Fall 2021
1. (5 points) On a single plot, graph these two measures of employment from Jan 1948 to
present. Comment on any differences you observe.
As with the previous assignment, take some time to make your chart look read-able.
Imagine an employer has asked you to brief a potential client with this information.
Attach your chart here or at the end of this problem set.
73-103 Principles of Macroeconomics Fall 2021
2. (10 points) On a single plot, graph the month-to-month change in employment for these
two measures from Jan 2006 to September 2019. Comment on any similarities and
differences you observe.
Note, we are looking for a simple difference. That is, if Xt represents an observation
of your data in month t, then we just want ?t = Xt ? Xt?1 . For our data, this result
represents the number of net new employees added over the past month.
Attach your chart here or at the end of this problem set.
73-103 Principles of Macroeconomics Fall 2021
3. (10 points) Based on your results in parts 1 and 2 above, briefly comment on which
measure you trust more and why. Feel free to refer to the linked technical note from the
Bureau of Labor Statistics above.
Transmission of material in this news release is embargoed until
8:30 a.m. (ET) Friday, October 8, 2021
USDL-21-1799
Technical information:
Household data:
(202) 691-6378 cpsinfo@bls.gov www.bls.gov/cps
Establishment data: (202) 691-6555 cesinfo@bls.gov www.bls.gov/ces
Media contact:
(202) 691-5902 PressOffice@bls.gov
THE EMPLOYMENT SITUATION SEPTEMBER 2021
Total nonfarm payroll employment rose by 194,000 in September, and the unemployment rate fell by
0.4 percentage point to 4.8 percent, the U.S. Bureau of Labor Statistics reported today. Notable job gains
occurred in leisure and hospitality, in professional and business services, in retail trade, and in
transportation and warehousing. Employment in public education declined over the month.
Chart 1. Unemployment rate, seasonally adjusted,
September 2019 September 2021
Chart 2. Nonfarm payroll employment, seasonally adjusted,
September 2019 September 2021
Percent
Thousands
16.0
160,000
14.0
155,000
12.0
150,000
10.0
145,000
8.0
140,000
6.0
135,000
4.0
130,000
125,000
2.0
Sep-19 Dec-19 Mar-20
Jun-20 Sep-20 Dec-20 Mar-21
Jun-21 Sep-21
Sep-19 Dec-19 Mar-20 Jun-20 Sep-20 Dec-20 Mar-21 Jun-21 Sep-21
This news release presents statistics from two monthly surveys. The household survey measures labor
force status, including unemployment, by demographic characteristics. The establishment survey
measures nonfarm employment, hours, and earnings by industry. For more information about the
concepts and statistical methodology used in these two surveys, see the Technical Note.
Househo
