💵Growth of the American Economy Unit 21 – Great Recession: Economic Impact & Recovery

What Caused the Great Recession?

• Housing market bubble fueled by subprime mortgages and lax lending standards
• Securitization of mortgages into complex financial instruments (mortgage-backed securities and collateralized debt obligations)
  • Allowed for the spreading of risk and increased liquidity in the housing market
  • Enabled investors to purchase shares in pools of mortgages, including subprime loans
• Credit default swaps used as insurance on mortgage-backed securities
  • Allowed investors to hedge against potential defaults
  • Created a false sense of security and encouraged excessive risk-taking
• Federal Reserve kept interest rates low in the early 2000s, encouraging borrowing and speculation
• Lack of proper regulation and oversight of the financial industry
  • Allowed for predatory lending practices and the proliferation of high-risk financial products
• Overleverage and excessive risk-taking by financial institutions
  • Banks and investment firms took on significant debt to invest in mortgage-backed securities
• Decline in housing prices led to a wave of defaults and foreclosures
  • As adjustable-rate mortgages reset to higher interest rates, many borrowers could no longer afford their payments

Key Economic Indicators During the Crisis

• Sharp decline in GDP growth
  • U.S. GDP contracted by 0.3% in 2008 and 2.8% in 2009
  • Quarterly GDP growth reached a low of -8.4% in Q4 2008
• Significant increase in unemployment
  • U.S. unemployment rate rose from 4.6% in 2007 to a peak of 10% in October 2009
  • Over 8 million jobs were lost during the recession
• Steep drop in home prices
  • The Case-Shiller Home Price Index fell by over 27% from its peak in July 2006 to its trough in May 2009
• Stock market crash
  • The S&P 500 index fell by 57% from its peak in October 2007 to its low in March 2009
• Tightening of credit markets
  • Banks significantly reduced lending to businesses and consumers
  • Spreads between Treasury yields and other interest rates widened, indicating heightened risk aversion
• Decline in consumer confidence
  • The Conference Board Consumer Confidence Index fell to a record low of 25.3 in February 2009

Impact on Different Sectors of the Economy

• Housing market collapse
  • Sharp decline in home prices and construction activity
  • Wave of foreclosures and defaults on mortgages
• Financial sector turmoil
  • Significant losses for banks and investment firms due to exposure to subprime mortgages and related securities
  • High-profile bankruptcies and mergers (Lehman Brothers, Bear Stearns, Merrill Lynch)
• Automotive industry crisis
  • Steep decline in vehicle sales and production
  • Government bailouts of General Motors and Chrysler
• Retail sector struggles
  • Reduced consumer spending led to bankruptcies and store closures (Circuit City, Linens 'n Things)
  • Shift towards discount retailers and online shopping
• Manufacturing sector contraction
  • Reduced demand for goods led to factory closures and layoffs
  • Particularly severe impact on durable goods manufacturing (machinery, electronics, furniture)
• Travel and tourism industry downturn
  • Reduced business and leisure travel due to economic uncertainty and job losses
  • Decline in hotel occupancy rates and airline passenger traffic

Government Response and Interventions

• Federal Reserve monetary policy actions
  • Lowered the federal funds rate to near-zero levels
  • Implemented quantitative easing programs to purchase Treasury securities and mortgage-backed securities
• Troubled Asset Relief Program (TARP)
  • $700 billion program to purchase troubled assets from financial institutions
  • Aimed to stabilize the financial system and restore confidence
• Economic Stimulus Act of 2008
  • $152 billion package that provided tax rebates to individuals and incentives for business investment
• American Recovery and Reinvestment Act of 2009
  • $831 billion stimulus package that included tax cuts, infrastructure spending, and aid to state and local governments
• Dodd-Frank Wall Street Reform and Consumer Protection Act
  • Comprehensive financial regulatory reform legislation passed in 2010
  • Established the Consumer Financial Protection Bureau and implemented new rules for the financial industry
• Bailouts and support for specific industries
  • Government loans and investments in the automotive industry (General Motors, Chrysler)
  • Mortgage modification programs to help homeowners avoid foreclosure (Home Affordable Modification Program)

Global Ripple Effects

• Worldwide economic downturn
  • Many countries experienced recessions or slowdowns in economic growth
  • Global GDP growth fell from 4.3% in 2007 to -1.7% in 2009
• Decline in international trade
  • Reduced demand for goods and services led to a sharp drop in global trade volumes
  • World trade fell by 12% in 2009, the largest decline since World War II
• European sovereign debt crisis
  • Several European countries (Greece, Ireland, Portugal, Spain) faced debt crises and required financial assistance
  • Concerns about the stability of the eurozone and the potential for contagion
• Emerging market volatility
  • Capital outflows from emerging markets as investors sought safer assets
  • Currency depreciation and increased borrowing costs for some developing countries
• Increased global economic interdependence
  • The crisis highlighted the interconnectedness of global financial markets and economies
  • Demonstrated the potential for financial shocks to spread rapidly across borders

The Road to Recovery

• Gradual improvement in economic indicators
  • GDP growth resumed in the second half of 2009 and continued to strengthen in subsequent years
  • Unemployment rate began to decline in 2010 but remained elevated for several years
• Slow recovery in the housing market
  • Home prices began to stabilize in 2012 but remained below pre-crisis levels for an extended period
  • Gradual reduction in foreclosures and increase in new home construction
• Rebuilding of household wealth
  • Stock market recovery helped to restore household wealth lost during the crisis
  • Deleveraging process as households paid down debt and increased savings
• Corporate profit rebound
  • Many companies adapted to the new economic environment and saw improved profitability
  • Low interest rates and cost-cutting measures supported corporate balance sheets
• Uneven recovery across regions and sectors
  • Some states and cities experienced more rapid recoveries than others
  • Certain industries (technology, healthcare) fared better than others (construction, manufacturing)
• Persistent long-term unemployment
  • Despite overall job growth, many workers experienced extended periods of unemployment
  • Structural changes in the economy and skill mismatches contributed to long-term joblessness

Lessons Learned and Policy Changes

• Importance of financial regulation and oversight
  • The crisis highlighted the need for stronger regulation of the financial industry
  • Dodd-Frank Act and other reforms aimed to address systemic risks and protect consumers
• Limitations of monetary policy
  • The Federal Reserve's actions helped to stabilize the financial system but had limited impact on the real economy
  • Low interest rates and quantitative easing raised concerns about potential asset bubbles and inflation
• Fiscal policy challenges
  • The use of fiscal stimulus measures led to increased government debt and long-term budget challenges
  • Debates about the appropriate balance between stimulus and austerity measures
• Macroprudential policy approaches
  • Increased focus on monitoring and addressing systemic risks in the financial system
  • Use of tools such as stress tests and capital requirements to enhance financial stability
• Global policy coordination
  • The crisis underscored the importance of international cooperation in responding to economic shocks
  • G20 meetings and other forums facilitated policy coordination and information sharing
• Rethinking economic models and assumptions
  • The crisis challenged traditional economic models and assumptions about market efficiency and rationality
  • Increased attention to behavioral economics and the role of psychology in financial decision-making

Long-Term Economic Consequences

• Slower productivity growth
  • The crisis and its aftermath led to a slowdown in productivity growth in many advanced economies
  • Factors such as reduced investment, skill mismatches, and regulatory uncertainty contributed to the slowdown
• Increased income and wealth inequality
  • The crisis exacerbated existing trends of rising income and wealth inequality
  • Uneven recovery and structural changes in the economy contributed to widening gaps between rich and poor
• Elevated government debt levels
  • Fiscal stimulus measures and reduced tax revenues led to significant increases in government debt
  • Concerns about long-term fiscal sustainability and the potential for future debt crises
• Changes in consumer behavior
  • The crisis led to a shift towards more cautious spending and borrowing habits
  • Increased emphasis on value, savings, and financial security
• Structural changes in the labor market
  • Accelerated trends towards automation and digitalization
  • Shift towards more flexible and contingent work arrangements (gig economy)
• Long-term impact on human capital
  • Extended periods of unemployment and underemployment can lead to skill erosion and reduced future earnings potential
  • Potential scarring effects on younger workers who entered the job market during the recession