The Great Recession
Introduction
Recession describes an economical state when there is a significant drop in general economic activity that is usually triggered by a lack of spending. There are various reasons and causes for this decline in spending some being, events like financial crisis, supply shock that have an adverse effect, and like in this case, due to bursting of an economic bubble. Other reasons can include natural disasters, pandemics, etc. These recessions have a harsh impact on economies, GDPs, employment, inflation, etc. Hence to curb the effects of these recessions, Monetary and Fiscal policies are adopted. These policies help control inflation, unemployment, and encourage economic activity, thereby curbing the effects of the recession. This policy action also has its effects on the IS-Lm framework by Keynes.
The Great Recession
The Great Recession describes the extreme economic turndown in the US between the years of 2007 to 2009, it was said to be the most severe macroeconomic event since the great depression of the 1930s. The Recession lasted for 19 months from December of the year 2007 and to June of the year 2009, gradually sinking employment and GDP. Over time the US adopted policies, out of which many but not all helped significantly in recovery. No known formal theoretical or empirical model was able to accurately predict the advance of this recession, except for minor signals in the sudden rise of forecasted probabilities, which were still well under 50%.
Causes
The causes of the Great Recession are numerous and can be traced back the years 2005–2006 when the US housing bubble burst, this was a vulnerability in the financial system, Witnessing the fall in housing prices the homeowners began to walk away from their mortgages, causing the mortgage-backed securities that were held by investment banks to decline in 2007–2008, this lead to the collapse in the fall of 2008. This particular phase was called the subprime mortgage crisis. Banks were failing to provide funds to private and public businesses and since homeowners were paying debts rather than borrowing or spending. This lead to the great depression of 2007–2009 (being declared in December of the same year). The report by the Financial Crisis Inquiry Commission stated that the recession was avoidable and presented the following causes:
1) Failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages.
2) Excessive borrowing along with the risk of households adversely affected the financial system.
3) Noticeable violation of accountability and ethics in policymaking.
4) Financial firms acting recklessly and taking on too much risk.
Consequences
As stated earlier, the recession has severe effects on economies. The Great Recession is a prominent one did not fall short, many important economic variables did not regain pre-recession levels until 2011–2016. There were many adverse effects, although compared to the recession of the 1930s, the effects were less extreme, GDP dropped by 0.3 percent in the year 2007, and fell further to 2.8 percent by the year 2009. ( US witnessed the drop of GDP by 10% in the 1930s). the United States alone shed more than 8.7 million jobs, according to the U.S. Bureau of Labor Statistics, causing the unemployment rate to double, the unemployment rate witnessed its peak at 10%, however, did not reach depression status. ( 25% in the recession of the 1930s). Bankruptcy was abundant, it was made evident by the declaration of bankruptcy by the Lehman Brothers the country’s fourth-largest investment bank, in September 2008.
Policies to curb effects
During the period of the great recession, the Federal Reserve adopted aggressive monetary policies that have been appreciated over the years to prevent greater damages to the economy, however many have also been discouraged and criticized for delaying the time of recovery from the recession.
During this time the Federal Reserve reduced interest rates to negligible percentages (almost zero), this was done to significantly expand the money supply and to promote liquidity, in an unprecedented move, provided banks with a staggering $7.7 trillion of emergency loans in a policy known as quantitative easing. In quantitative easing( An Unconventional Monetary Policy) the central bank purchases longer-term securities from the open market to increase the money supply and thereby promoting investment, this policy was also adopted in Japan during the Asian Financial Crisis of 1997. This policy was also criticized on the grounds that this massive monetary policy response in some ways represented a doubling down on the early 2000’s monetary expansion that fueled the housing bubble in the first place. There is a chain of events that follows when the Federal Reserve buys the securities; once feds buy securities there is a noticeable increase in money supply, this led to the fall in interest rates, once the rates fell investment was encouraged and thereby eventually leading to an increase in output (this process increases economic activity).
Why Quantitative Easing?
It is more than evident that Expansionary monetary policies such as regulating the cash reserves of commercial banks to increase the availability of loanable funds or buying short-term Government bonds also help increasing the money supply and thereby lower short-term interest rates. However, when the interest rate is already either at or close to zero, like in this case, Quantitative easing is a monetary policy used then to boost the economy by purchasing financial assets of longer maturity, that cause the lowering of long-term interest rates too.
The effect of Quantitative Easing Monetary Policy in the IS-LM framework.
Fed buys securities -> money supply increases in economy -> interest rates fall -> opportunity for investments with attractive loans -> output increases
The corresponding graphs are shown below:
Once there is an increase in the money supply, it is followed by a decline in interest rates, which finally leads to an increase in money demand.
As presented in the above diagram, it can be seen that the monetary policy causes an increase in money demand and thereby causes the LM curve to shift rightwards or outwards, that being said, there is no effect on the IS curve except for the movement along the line due to the shift in LM curve. The new lower rate (i2) induces investment and hence, higher output. Thus, the new equilibrium O’ is reached at a lower interest rate (i2) and higher output (Y2).
Other Measures
Along with monetary policies, Federal Govt. also resorted to giant fiscal policy programs including trying to stimulate the economy in the form of the $787 billion in deficit spending under the American Recovery and Reinvestment Act, according to the Congressional Budget Office. Etc.
Conclusion
In the given circumstances adoption these policies were viable, execution of these policies led to curbing of the effects of the recession, however, these monetary and even fiscal measures only prevented immediate losses that were to be incurred by the large financial corporation, but due to the prevention of liquidation, they kept the economy locked in the same economic and organization structure that contributed to the crisis, in simpler words it meant that tidal wave of liquidity and deficit spending did much to prop up politically connected financial institutions and big business at the expense of ordinary people. This tied up real economic resources that lead to delay in recovery. The Monetary policy of quantitative easing adopted, though seemed viable had failed to have an expected impact even though it has helped stabilize the economy in the short run. Presumably, due to the high unemployment rate, high unemployment leads to lesser borrowings.
References
Amadeo. K (2020). “The Great Recession of 2008 Explained With Dates”. Retrieved from
https://www.thebalance.com/the-great-recession-of-2008-explanation-with-dates-4056832
Pettinger. T (2019). “The great recession 2008–13”. Retrieved from
https://www.economicshelp.org/blog/7501/economics/the-great-recession/
Amadeo. K (2020). “Explaining Quantitative Easing — QE”. Retrieved from
https://www.thebalance.com/what-is-quantitative-easing-definition-and-explanation-3305881
Bird. M (2014). “A beginner’s guide to quantitative easing”. Retrieved from
https://www.weforum.org/agenda/2014/11/a-beginners-guide-to-quantitative-easing/
Coghlan. E (2018). “What really caused the Great Recession”. Retrieved from
https://irle.berkeley.edu/what-really-caused-the-great-recession/
Cregger, H. (2015). How to Recover from the Great Recession and Reduce the Government Debt, Best Integrated Writing, 2.
Irons. J (2009). “Economic scarring”. Retrieved from
