PRINCIPLES OF MACROECONOMICS PART IV Further Macroeconomics Issues TENTH EDITION CASE FAIR OSTER © 2012 Pearson Education, Inc Publishing as Prentice Hall Prepared by: Fernando Quijano & Shelly ofTefft 24 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc Publishing as Prentice Hall of 38 PART IV FURTHER MACROECONOMICS ISSUES Financial Crises, Stabilization, and Deficits 15 CHAPTER OUTLINE The Stock Market, the Housing Market, and Financial Crises PART IV Further Macroeconomics Issues Stocks and Bonds Determining the Price of a Stock The Stock Market Since 1948 Housing Prices Since 1952 Household Wealth Effects on the Economy Financial Crises and the 2008 Bailout Asset Markets and Policy Makers © 2012 Pearson Education, Inc Publishing as Prentice Hall Time Lags Regarding Monetary and Fiscal Policy Stabilization Recognition Lags Implementation Lags Response Lags Summary Government Deficit Issues Deficit Targeting of 38 The Stock Market, the Housing Market, and Financial Crises Stocks and Bonds stock A certificate that certifies ownership of a certain portion of a firm capital gain An increase in the value of an asset PART IV Further Macroeconomics Issues realized capital gain The gain that occurs when the owner of an asset actually sells it for more than he or she paid for it © 2012 Pearson Education, Inc Publishing as Prentice Hall of 38 The Stock Market, the Housing Market, and Financial Crises Determining the Price of a Stock Stock prices are affected by people’s expectations of future dividends The larger the expected future dividends, the larger the current stock price, other things being equal PART IV Further Macroeconomics Issues The farther into the future the dividend is expected to be paid, the more it will be “discounted.” The amount discounted depends on the interest rate The larger the interest rate, the more expected future dividends will be discounted The discount for risk must also be taken into account The price of a stock should equal the discounted value of its expected future dividends, where the discount factors depend on the interest rate and risk Stock prices may also depend on what people expect others will pay for the stock in the future, bringing about stock market “bubbles.” © 2012 Pearson Education, Inc Publishing as Prentice Hall of 38 The Stock Market, the Housing Market, and Financial Crises The Stock Market Since 1948 Dow Jones Industrial Average An index based on the stock prices of 30 actively traded large companies The oldest and most widely followed index of stock market performance PART IV Further Macroeconomics Issues NASDAQ Composite An index based on the stock prices of over 5,000 companies traded on the NASDAQ Stock Market The NASDAQ market takes its name from the National Association of Securities Dealers Automated Quotation System Standard and Poor’s 500 (S&P 500) An index based on the stock prices of 500 of the largest firms by market value © 2012 Pearson Education, Inc Publishing as Prentice Hall of 38 The Stock Market, the Housing Market, and Financial Crises PART IV Further Macroeconomics Issues The Stock Market Since 1948 FIGURE 15.1 The S&P 500 Stock Price Index, 1948 I–2010 I © 2012 Pearson Education, Inc Publishing as Prentice Hall of 38 The Stock Market, the Housing Market, and Financial Crises PART IV Further Macroeconomics Issues The Stock Market Since 1948 FIGURE 15.2 Ratio of After-Tax Profits to GDP, 1948 I–2010 I © 2012 Pearson Education, Inc Publishing as Prentice Hall of 38 ECONOMICS IN PRACTICE Bubbles or Rational Investors? PART IV Further Macroeconomics Issues The huge increase in U.S stock prices in the last half of the 1990s is a puzzle So also is the huge increase in U.S housing prices between 2002 and 2006 Many other countries have seen large increases in asset prices since then as well An interesting question is whether these rapid run-ups in prices are bubbles, generated by irrational consumers and investors, or are instead the result of actions of rational investors that simply turned out with hindsight to be wrong A key policy question is whether the Fed should ignore asset prices or try to use interest rates to control them Bernanke’s Bubble Laboratory: Princeton Protégés of Fed Chief Study the Economics of Manias The Wall Street Journal © 2012 Pearson Education, Inc Publishing as Prentice Hall of 38 The Stock Market, the Housing Market, and Financial Crises PART IV Further Macroeconomics Issues Housing Prices Since 1952 FIGURE 15.3 Ratio of a Housing Price Index to the GDP Deflator, 1952 I–2010 I © 2012 Pearson Education, Inc Publishing as Prentice Hall 10 of 38 ... Prentice Hall 12 of 38 ECONOMICS IN PRACTICE Financial Reform Bill PART IV Further Macroeconomics Issues In July 2010 in the aftermath of the financial crisis and subsequent bailout of much of the U.S... the National Association of Securities Dealers Automated Quotation System Standard and Poor’s 500 (S&P 500) An index based on the stock prices of 500 of the largest firms by market value © 2012... Prentice Hall of 38 The Stock Market, the Housing Market, and Financial Crises PART IV Further Macroeconomics Issues The Stock Market Since 1948 FIGURE 15.2 Ratio of After-Tax Profits to GDP,