Chapter 14

14.1 The Stock Market, the Housing Market, and Financial Crises
- Discuss the effects of historical fluctuations in stock and housing prices on the economy.
14.2 Time Lags Regarding Monetary and Fiscal Policy
- Explain the purpose of stabilization policies and differentiate between three types of time lags.
14.3 Government Deficit Issues
- Discuss the effects of government deficits and deficit targeting.

What accounts for the large fluctuations in the unemployment rate?
Why can’t policymakers do a better job of controlling the economy?
This chapter seeks to answer these questions by first considering the interrelationship between the stock market and the housing market and their effects on the economy through the household wealth effect.

Stock: A certificate that certifies ownership of a certain portion of a firm.
Common Stock: A certificate representing ownership of a share in a business, particularly in a corporation.
Shareholders: Individuals or entities that own shares of stock and are entitled to a portion of the company's profits.
- Dividends: Payments made directly to shareholders from a corporation's profits.

Capital Gain: An increase in the value of an asset.
Realized Capital Gain: The profit that occurs when an asset is sold for more than the purchase price.
Total Return: The overall return to a stockholder, calculated as the sum of dividends received and capital gains or losses.

Stock prices correlate significantly with the expected future dividends; greater expected future dividends lead to higher current stock prices, other factors being equal.
The price of a stock is determined using present discounted value formulas, factoring in interest rates and associated risks.
Stock Market Bubbles: Occur when prices ascend beyond their actual worth due to speculative expectations.

Dow Jones Industrial Average: An index reflecting stock prices of 30 actively traded large companies; the oldest and most recognized stock market index.
NASDAQ Composite: An index representing stock prices of over 5,000 companies traded on the NASDAQ stock market, an automated quotation system.
Standard & Poor’s 500 (S&P 500): An index comprising stock prices of 500 large firms based on market value.

Housing prices were generally aligned with the overall price level until a significant deviation began in 2000.
A massive increase in housing prices occurred from 2000 to 2006, followed by an equivalent decline from 2006 to 2009, leading to a loss in value of approximately $7 ext{ trillion}$ in housing wealth.

Changes in household wealth primarily result from fluctuations in stock and housing prices.
Increased stock and housing values lead households to feel wealthier, prompting higher consumption and spending.
Higher stock prices make investment projects more affordable as it reduces the cost in terms of stock equity.

Financial crises exacerbate macroeconomic issues caused by declining stock or housing markets.
The decline in housing prices beginning in 2006 is often linked to the financial crisis spanning 2008-2009.
In response, the federal government approved a bailout in October 2008, aiding significant financial institutions troubled by mortgage market issues.
The Federal Reserve's intervention involved the purchase of substantial amounts of mortgage-backed securities.

Economists struggle with predicting recessions, illustrated by the 2008-2009 recession where downturns were driven by unpredictable declines in housing and stock prices.

Stabilization Policy: Encompasses both monetary and fiscal policies aimed at moderating fluctuations in output and maintaining price stability.
Time Lags: Delays occurring in the economic response to stabilization policies.

Recognition Lag: The period taken for policymakers to identify the occurrence of an economic boom or slump.
Implementation Lag: The time needed to execute the desired policy after recognition.
Response Lag: The duration for the economy to adapt to new conditions following the implementation of a policy.

Analysis of GDP paths illustrates how stabilization attempts can destabilize if time lags are not adequately managed.
Incorrect timing in applying policy can lead the economy towards undesirable outcomes further from the intended goals.

Engaging in economic stimulation via tax reductions or spending increases typically enlarges the government deficit.
Cyclical Deficits: Short-term deficits arising from recessions which are not detrimental long-term.
Structural Deficits: Persistent deficits that can produce negative consequences when the economy is at full employment.

The deficits starting in 2008 resulted in a sharp increase in the federal debt-to-GDP ratio, with projections indicating continued rises without significant policy intervention.

Gramm-Rudman-Hollings Act: An act executed by Congress in 1986 aimed to reduce the federal deficit by $36 ext{ billion}$ annually and aimed for a zero deficit by 1991.
Automatic Stabilizers: Fiscal items in the budget that dynamically adjust to stabilize GDP.
Automatic Destabilizers: Elements that change with the economy but tend to destabilize GDP instead of stabilizing it.

Deficit targeting alters economic responses to negative demand shocks, likely leading to lesser deficits but greater overall income declines.
Imposing restrictions on spending or tax measures during economic downturns is regarded as counterproductive.

Policymakers must create alternative strategies for managing escalating structural deficits while avoiding detrimental impacts on economic stability.