How the Great Recession Still Affects People's Perceptions

January 15, 2020
Julian Kozlowski | St. Louis Fed

This 14-minute podcast was released Jan. 15, 2020.

“Many years after seeing the Great Recession, we still think that the possibility of seeing a financial crisis again in the U.S. is positive,” says Julian Kozlowski, economist at the Federal Reserve Bank of St. Louis. He talks with Matuschka Lindo Briggs, a media relations coordinator at the St. Louis Fed. They discuss Kozlowski’s research on the Great Recession and how it changed people’s perceptions.


Matuschka Lindo Briggs: Welcome to the Timely Topics Series from the St. Louis Fed. I’m Matuschka Lindo Briggs, your host for this podcast. With me today is Julian Kozlowski, an economist in the Research division of the Federal Reserve Bank of St. Louis.

Julian, thanks for joining us today.

Julian Kozlowski: Thanks for having me on the program.

Lindo Briggs: First, if you can just share a little bit about yourself and where you’re from, and tell us some of your education.

Kozlowski: Absolutely. It’s a pleasure to be here with you. So I‘m originally from Argentina. I grew up there and I went to school there. And then I moved to the U.S. for grad school. I was living in New York for about six years. And I moved to St. Louis to work here at the Federal Reserve Bank a year ago.

Lindo Briggs: Well, we are very lucky to have you. Our main focus for today‘s podcast is going to be about the recession and how it changed people’s perception and increased tail risk. But before we get into the details, Julian, I’d like you to take us back in time. Let’s say you’re doing a lecture before the Great Recession. What were people’s perceptions about a possible financial crisis? Then, lead us into today and what the perception is today, after the crisis.

Kozlowski: That’s a great question. The thing we are in, say, 2005. We are recording a podcast about financial crisis. And I ask both you and the audience, what do you think is the likelihood of seeing a large financial crisis in advanced economies, say in the U.S.?

Lindo Briggs: Well, obviously in 2005, I would say, with our country that would be impossible. That would not happen.

Kozlowski: Those were the beliefs before the financial crisis. Yet, fast forward a while a couple of years: 2008, 2009, we have the Great Recession, a very large financial crisis that was not only impacting the U.S., but the whole economy and many countries in Europe, Asia. It was a very big and unexpected financial crisis. Seeing these type of events changed the perception of people about what’s the probability of seeing those again.

So let me give you an example: So we are playing dice, as in the casino. We see a couple of times and the numbers one to six came about with the same frequency. So we are probably agreed that this is a standard, six-sided dice, and each of the sides has the same probability. But let’s say that now I roll it one more time, and we see a seven. We would be shocked and surprised.

Lindo Briggs: Absolutely.

Kozlowski: That was not expected. So let me ask you now, what do you think is the probability of seeing a seven again?

Lindo Briggs: I would think still not very likely.

Kozlowski: But yet positive. And if you have to make bets on this, I guess you’re going to think with some positive probability, you expect to see the seven again.

Lindo Briggs: Correct.

Kozlowski: Even if we roll the dice a couple of more times, and we continue rolling, and we, we only see one to six, we have in our memories that we’ve seen the seven a couple of rolls ago. And, as such, you, you will still have in your memory that the seven is possible. And so many years after seeing the Great Recession, we still think that the possibility of seeing a financial crisis again in the U.S. is positive. And that changed the perception of people, and they acted to slow our risks.

Lindo Briggs: So does it surprise you that it’s 10 years later and we still kind of have this fear, say of, the die being another seven rolling or another recession is a possibility? It’s almost always in the news: Is it coming? Is it coming? Is it a fear that now we can’t get rid of because we’ve seen it once?

Kozlowski: That’s a good question. So I was kind of surprised as well as you were describing that 10 years after the financial crisis, and yet we see a lot of economic variables that are very different than in the pre-crisis period. For example, we have very low interest rates. And output is being recovered back to trend, investment was below trend for many, many years. And I was surprised for those facts. So, actually, I have research with some colleagues in New York University and Columbia University that actually were trained to understand: What are the possible consequences? Why is that we see these long-run effects of the financial crisis?

And overall our conclusion is the change in the actual tail risk, particularly having seen the financial crisis, have very persistent effects on the belief of the people, both investors, policymakers, and households. And that can generate very long lead effects on the aggregate economy.

Lindo Briggs: So that’s what you’re studying. So it’s the change of our perception and the way we’re playing the game, I would say, in the economy. So that’s what’s considered the tail risk, right? It’s a change in the elevated tail risk?

Kozlowski: Yes, exactly.

So it’s basically what I’m studying is, how the change in the perceptions about the risk before and after the crisis can affect, say, investment decisions in the market, for instance.

Lindo Briggs: And what are you seeing now? Tell us a little bit more about your research. What is the effect of the elevated tail risk?

Kozlowski: Well, what we found is that it’s actually affecting many different markets. So, for example, we see that we are in an environment of very low interest rates. And actually, we can attribute these low interest rates to the interaction of increasing the risks, which in turn affects the liquidity of those assets.

So let me explain to you what I mean by liquidity. When I say liquidity, imagine we are selling a house. And suppose you have a two-bedroom apartment in Manhattan that you’re trying to sell. I’m going to say that that’s very liquid. It’s very easy to sell, that it’s a big market, a lot of people buying and selling apartments in Manhattan. And so it’s going to be easy to buy and sell. It’s going to be very liquid.

Lindo Briggs: OK.

Kozlowski: But now think about another property. Say we, we are in St. Louis, and we receive some inheritance, a big farm, a ranch.

Lindo Briggs: OK. So, like, tons of acres. Big ranch.

Kozlowski: Exactly. It was, say, it was from our family that they used to be ranchers there. And by now we are in the city, and we don’t want that property. So we want to sell it. Well, selling that type of property is going to be probably very hard. We need to find a counterpart that is willing to buy and is looking for that specific type of property. That is going to be much more hard to sell than a two bedroom apartment in Manhattan. Those effects, the liquidity of these apartments are going to affect the price of the apartments and the houses. That’s going to affect the liquidity value.

We can see the same effects on financial assets and for example in Treasuries. U.S. Treasuries, the government—the debt of the U.S. government are very liquid. There is a lot of demand for those assets. Those prices are going to be high, implying very low interest rates. So in particular, what we see is that both in my research and the research of other people, is that after the financial crisis, there was an increase in the liquidity services provided by Treasuries, which is pushing down interest rates nowadays.

Lindo Briggs: So would you say that’s good, or is it bad? Is there one way to look at it when you think of liquidity and the interest rates being pushed down?

Kozlowski: Well, good and bad is making some type of welfare implications. What I’m seeing right now is a descriptive view, what I see in the data, what make a rationale for what I see in the data in the economy. I’m not saying that it is either good or bad. I’m trying to understand: What are the forces that generate what we see in the data?

Lindo Briggs: OK. So I understand, but as a layperson, should we be interested and concerned in the liquidity and what’s happening?

Kozlowski: Absolutely. Think about the household. You should be thinking about, say, durable assets that you have. You have a car. You might have a house. You may have a bike. All those are assets. All those goods willhave liquidity properties. When you’re buying and selling this stuff, you have to think, OK, if this is very liquid or very illiquid, I will require a different price for buying and selling those type of assets. And the same with financial assets. If you have some savings, you should be paying attention: What type of assets are you saving?

So, for example, if you have some money that you’re saving for some emergency, you want that to be very liquid because, say you have some—you need the money to go to the doctor or to pay to college or you have some extra bills, you need to convert that asset quickly into money. But if you have other money that you are saving for retirement or looking forward, well, there is time you don’t need that to be effectively, immediately very liquid. So you can invest in more illiquid stuff. So a person should be thinking about liquidity in all aspects of their life, absolutely.

Lindo Briggs: Why do you think that this financial crisis, this Great Recession, scarred beliefs and perceptions in a way that other recessions did not?

Kozlowski: You know, that’s a very interesting question. What I think is different from the last financial crisis and previous ones was, in large, the size of the crisis. You may know, in 2001, there was a recession in the U.S. economy, but we’ll call it “a standard recession.”

Lindo Briggs: OK.

Kozlowski: The economy went down and then recovered as in previous periods. And every, every five or 10 years, it depends, you will see the economy fluctuating around. Those are what I call, like, standard business cycles. The economy moves up and down.

There is a lot of uncertainty. We don’t know what’s happened, but we have some expectation about where the economy is going to be moving around. Sometimes it’s going to go up, and sometimes it’s going to go down. And that’s what people in general expect in the economy. The financial crisis was very different because it was a very large shock. The downturn was very deep. And that was not expected. And in that sense, the last crisis was different than previous ones.

Lindo Briggs: So it was very deep, and it was very long. And that’s a perception that’s now hard to change?

Kozlowski: Absolutely. And it’s going to take many, many years until we change our perceptions about what’s the probability of seeing a financial crisis again. And it’s all over the news, every time you open the newspaper or discussions, you will see that people are fearful about having a new financial crisis, which was not the case before 2008.

Lindo Briggs: Exactly. It’s almost always a question. Is it now? Is it coming again? It’s, it’s, it’s…

Kozlowski: Exactly.

Lindo Briggs: …almost a fear that you can’t get rid of.

Kozlowski: Exactly. Because seeing such event changed our perceptions.

Lindo Briggs: Right. Would you say that an elevated tail risk will always mean or bring low interest rates?

Kozlowski: Well, that depends, I guess. There is a channel, which I described to you before, that is coming through the liquidity in which, in moments in which there is a lot of fear about the financial crisis, the demand for liquidity increases, and that’s going to be pushing down interest rates. But the economy can receive other types of shocks. So, for example, the economy can transition to a new scenario where there is a lot of supply of liquid assets. So a as everything in the economy it’s supply and demand.

So what my claim is that, given the supply of safe assets, there is a high price for liquidity which is pushing down interest rates. If for some reason there is a change in the economy, there is an increase in the supply of safe assets, then that’s going to imply that, in equilibrium, the price of liquidity will diminish, and that’s going to increase interest rates again. It’s going to depend on demand and supply.

Lindo Briggs: So tell me a little bit about what’s next, what you’re looking at. Are you going to continue to look at the tail risk and the liquidity? As researchers, you don’t really hope for one thing or another. What do you expect to happen in the research that you’re studying now when you look at liquidity?

Kozlowski: That’s a good question. I think that there are still a lot of open questions about how is the interaction of liquidity and the real economy. How, for example, a new paper I’m thinking about writing about, is how liquidity interacts with monetary policy decisions. So, for example, one question I’m asking, when the Fed is deciding interest rates, and they change interest rates, that can affect the liquidity of the economy. And that can, in turn, can affect investment and saving decisions. We don’t know what is exactly this channel and how it works, and that’s something I’m working on right now.

Lindo Briggs: So basically it’s safe to say that we are in an environment of low interest rates after the crisis due to the way our perception is right now, and due to liquidity.

Kozlowski: Yes. I would say that there is not complete agreement on the research world about this statement. But I’m pushing forward that line of thought.

Lindo Briggs: Is there anything else that you want to share with us that you’re working on or looking to work on?

Kozlowski: I’m working on this paper that is also related to liquidity, which is, I’m studying interaction of how monetary policy interacts with liquidity, and how it can affect investment decisions. I think that there are many open questions in this line of research, that we don’t know exactly, when the Fed changes interest rates, how the participations in the markets change, and how this, in turn, affects the economy. So that’s something that I’m working on right now to try to understand—have a better description of the transmission of monetary policy through the liquidity channel.

Lindo Briggs: Why such a deep interest, Julian, on liquidity?

Kozlowski: I started working on it in grad school. My advisers were working on similar topics. And I got into it, and I cannot stop thinking about it.

Lindo Briggs: Oh, that’s a good answer. Thank you so much for joining us. I appreciate having you break down how an increase in tail risk has affected economic costs of the return on safe and liquid assets. So, again, thank you so much for being with us.

And for more on Julian’s research, you can go to, then click on “research and data” followed by “economists.”

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Economists and experts talk about their research, topics in the news and issues related to the Fed. Views expressed are not necessarily those of the St. Louis Fed or the Federal Reserve System.

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