RM's+Economic+Research

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This is a new project that BH and I are undertaking, as the two of us are on the Fed Challenge team at school. Economics is often referred to as the "dismal science", and because it is a social science, we thought it would add another dimension to the research program as well as enable us to update on a more regular basis.

So a few of the fundamental questions facing the economy are...
 * How much worse will the economy get before it recovers?
 * When will the economy turn around?
 * What are the indications that the economy is recovering?


 * __Background History__**

In order to understand these questions, there are several indicators, spreads, and other measures that are used to make predictions. Among these are retail sales, inflation expectations as measured by the TIPS spread, the unemployment rate, current inflation (PCE, CPI), default rates, inventories, etc.

There are many references in the news to complex financial instruments that led to this entire mess. So perhaps what needs to be explained is how this whole credit and financial crisis came about as a result of the collapse of the housing market....the following video is a very good visualization of the crisis. It's very easy to understand.

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The video highlights a few important terms like CDO's (Collateralized Debt Obligations), sub-prime mortages, mortgage-backed secrities, and leveraging. The credit crisis, is, in effect, a credit freeze -- banks won't lend, households aren't trusting banks, people are defaulting on their mortgages, and the value of people's assets are sprialling downward. Add to that a deteriorating labor market, fears of deflation and global growth approaching 0%, and you see a definite financial mess.

Deflation....why is it so bad? One would expect that a general decrease in prices is welcome, but it certainly is not, especially in this situation. What our economy is currently experiencing is //disinflation//, a slowing in the growth of prices. //Deflation//, however, hurts people in debt, because they value of the debt they pay back to creditors is worth more than the loan they initially took out. Therefore, in this credit crisis where so many loans were taken out by investors and homeowners, the value of the debt that they have to pay back is worth more than the loan they initially sought. Granted, many of these loans should not have been made in the first place, especially sub-prime loans, loans that had very few required qualifications or assurance that the loan would be repaid.

Deflation causes something called a "deflationary spiral" -- a self-feeding catastrophic event that happened during the Great Depression. A major difference, however, is the policy used to counter it. Wherease in the 1930's, policy actions were pro-cyclical, intensifying the depression, today's economic policies are counter-cyclical in order to ease and reverse the effects of a depression.

As told by WIRED magazine, there was one specific mathematical formula that fueled risk-taking on Wall Street (click here to find out more).