The Great Recession Of 2008-Causes And Consequences

Introduction

The global economy witnessed a significant downturn in world economics, known as the Great Recession 2008. The Great Recession was a result of the financial crisis that happened between 2007 and 2009. The crisis shocked scholars, financial institutions, governments, and policymakers, as most never expected such an outcome. Most of the people from America and other parts of the world were affected. There was widespread market instability, hurting financial, commercial, and consumption institutions. The economy had reduced money supply as the credit dried up, and the American market was mainly built on credit. Do you need urgent assignment help ? Get in touch with us at eminencepapers.com. We offer assignment help with high professionalism.

Mortgagers suffered as well as there was a decline in the housing market. Labor market instability was rising, with high unemployment rates, massive job losses, and reduced real wages. Also, the global market was significantly affected as the United States Dollar was the base currency for most foreign exchange of goods and services. In this study, there is an investigation of both the causes and consequences of the Great Recession. To develop these causes and consequences, a review of related literature aims to establish the leading causes and effects of the great depression. After examining the literature, the Study provides a summary and conclusion of the causes and consequences of the Great Recession.

The objective of the Study

To investigate the causes of the Great Recession between 2008 and 2009. To establish the consequences of the great depression between 2008 and

Literature Review

The literature review section evaluates related literature and peer-reviewed literature, which is used to support the study’s primary objective. It involves investigating previous studies and theories about the causes and effects of financial crises.

A market’s functioning depends on its financial markets’ stability. Through the financial markets, most economies can utilize capital resources from the form of factors of production into proper productive use. The financial markets are also responsible for identifying economic and unexpected economic risks, providing a haven for insurance. An empirical study by King and Levine (1993) shows that the strength of an economy is based on the stability of financial markets. Also, the Study by Rajan and Zingales (1998) supported this by describing that the faster the financial market grows, the better a country’s economy, mainly in terms of business growth and investment.

Therefore, a country needs to achieve financial market stability to prevent the adverse effects that may arise due to financial crises in the financial market. These crises can bring about an unstable exchange rate, nonperforming credit facilities, and, even worse, a lack of credit for investment purposes. Countries, thus, have to achieve stability in the financial market to avoid the risk of failure of the economy.

Monitoring financial market behavior can be a tool for signaling any deformity in the economy. There are issues like the bankruptcy of companies as well as unexpected changes in economic and financial variables. For example, the 2008 Great Recession had been preceded by the bankruptcy of Lehman and Brothers, which signaled a financial crisis in the market.

Therefore, there is a need to investigate macroeconomic variables such as bank insolvencies and bank failures to develop a strategy that may help prevent the trigger of a financial crisis in the market. Although challenging, policymakers can investigate stocks’ financial flows and performance in the financial markets. An example was the Study by Caprio (1991), which examined why there are sudden reductions in the capital inflows into a country. This may result in a looming financial crisis, or that has already started to happen.

Moreover, to determine if an economy is in a financial crisis, there is a need to investigate the performance of government bonds, stocks, and housing assets. A significant loss in the value of these crucial assets may be a substantial failure in the financial markets, which needs to be evaluated and investigated (Rey, 2015). These assets are essential aspects of the statement of financial positions of different companies and individual consumers, and their reduced performance may signify the loss of value. For example, a fall in the value of assets would mean that a firm or household cannot provide security for debt capital that can be used to finance further investment projects. Thus, lenders will then fail to advance loans, leading to the failure of the credit market.

Also, in another study by Berger & Bouwman (2017), financial crises may result from exchange rate crises. This may be very detrimental if there are foreign currency liabilities, as the exchange rates are subject to high volatility and may result in financial crises in such companies. An example was the collapse of the European exchange rate mechanism in the early 1990s, resulting in a spillover in the financial system.

Therefore, there is a need to watch the exchange rate movement to avoid foreign currency deficits, which will likely hurt individual firms and lead to financial issues (Berger & Bouwman, 2017). Critically, policymakers and other stakeholders have to relate exchange rate crises with bank crises to establish whether there exists a financial crisis in an economy.

On the other hand, financial crises may lead to sabotage in economies, such as a reduction in the general national output of a country. The decline in the national output means the state is not performing better as it cannot achieve economic growth and development (Karl, 20017). Therefore, this may result in a stagnating economy with low investment and expenditure, and the country cannot meet its citizens’ per capita needs, leading to an economic decline.

In the Study of Garrison (2001), financial crises may result from overinvestment in the economy. In this case, investors will always underestimate the risks in the market at the expense of achieving overestimated returns. In most cases, this happens because investors base their decisions on current prices without examining future market outcomes, which may help them make salient investment decisions. Therefore, although a project may forecast future increases in value, the long-term effect may be hazardous since common factors, such as changes in interest rates and market volatility, affect the performance of investments. A boom may exist in the market, yet it may indicate a looming recession or financial crisis.

Nevertheless, a financial crisis can result from the supply side effects in the economy, for example, misallocation in the capital and labor markets (Mendoza, 2010). These supply-side effects harm the financial market since they directly channel these resources into their productive uses. The misallocations hamper the financial market’s ability to perform effectively, resulting in an economic crisis as supply-side effects have short-, medium–, and long-term effects on the economy of a particular country. Capital misallocation occurs in changes in the credit facility market, which becomes depressed due to the overwhelming and persistent financial crisis (Mendoza, 2008). Capital available is reallocated to address these issues, which may not always result in positive results. Also, the labor market reallocation may fail since government intervention may not be sufficient to ensure the security of jobs for its locals, thus leading to increased unemployment in a country.

Analysis

In this section, the Study evaluates the objective of the Study by establishing the causes and consequences of the Great Recession.

Cause of the Great Recession 2008

Failure of the American financial market

There was a persistent misallocation of capital by the financial markets. These markets were self-regulated, contributing to the financial crisis since there was no government regulation regarding market failure (Mittra & Bhattacharya, 2011). Therefore, this worsened with increasing low interest rates prevalence by many lenders. Many companies were bailed out due to liquidity flooding. These persistent bailouts signified the eminent financial crisis in the country.

Loose Monetary Policy and Global Imbalances

In the United States, there was a reduction in the interest rates, which declined up to 1%. The interest rates were reduced in response to the economic condition of 2001. However, this was not well received in the market as it led to increased economic debt consumption. It was considered a loose monetary policy as the economy could not withstand the increased output in the housing market. Due to this, there were rising global imbalances in the oil market due to many companies creating dollar-denominated reserves in the United States. Therefore, this led to excessive saving by surplus countries and excessive consumption by deficit countries such as the United States, which resulted in the financial crisis. The US dollar was heavily relied upon as the primary base currency. Yet, it was exposed to financial risks due to the lapse in the financial markets and loose monetary policies. Search for Higher Yields

Investors were encouraged to seek higher returns due to low interest rates and yields on government bonds. Therefore, this led to investors’ demand for mortgage-backed securities since there was a high probability of future returns (Wray, 2008). However, this was a challenging venture as most investors failed to consider the risks associated with the mortgage-backed securities market. Lending increased, and there was no regulation on the part of the government, which led to increased risk as the housing market yielded more and more profits. Due to this, a housing bubble in the market further contributed to the financial crisis.

Minimal Financial Regulation

There was little and even no financial regulation in the United States. Most financial institution was left to self-regulate themselves as no governing standards could be adopted or followed (Shah, 2009). Therefore, this led to increased overlaps in the financial market as the interest rates increased beyond reasonable levels, failing to anticipate future economic outcomes. The financial market should have been regulated to reduce the impact of low interest rates on the economy.

Consequences of the Great Recession of 2008

The Decline in the Housing Market

The housing market slumped due to increased mortgage adjustment rates (Lewis, 2009). Due to this, mortgages were expensive to acquire, most homeowners defaulted the mortgages, and the burden was left to investors and financial institutions to bear. Therefore, the mortgage-backed securities started to incur losses, leading to money outflow from banks and other lenders. Eventually, the housing market was affected severely as there was a decline in housing prices, which meant that the houses became cheaper, even much less worth than their actual value. Most of the people opted to rent houses rather than buy them.

Deterioration of the Labor Market

Unemployment rates increased primarily in the Organization of Economic Cooperation of Developing (OECD) countries from 5.7% to 8.6% between 2007 and 2009. The International Labor Organization (ILO) estimated that around 200 million people were unemployed across the globe due to the financial crisis (Verick & Islam, 2010).

However, in some countries like Germany, the labor market was not significantly affected as it remained stable. The financial crisis exposed the labor market to external shocks, which increased the levels of unemployment rapidly as many companies were out of business and people lost their jobs.

The labor market is still in crisis even though most developed and developing economies have developed recovery programs to address labor issues. The unemployment rates are increasing in most OECD countries since the financial crisis led to reduced economic growth as significant companies were affected. Fewer job openings in these countries could have tapped the increasing unemployed population, especially youth and structural unemployment.

In the United States, there was a massive reduction in wages and a loss of careers by employees during the Great Recession. There was a decrease in real wages, which meant employees suffered the risk of losing employment benefits and contributions (Katz, 2014). The effect of the reduction in accurate fees was also experienced in Europe and Japan. The outcome resulted from the inverse relationship between inflation and the rate of employment, as it was explored by Phillip’s curve, where an increase in inflation leads to a reduction in the prices of employment as real wages decrease. People lose jobs (Blanchard & Gali, 2007).

The Decline in the National Output

The 2008 Great Recession decreased the gross domestic product (GDP) levels among different countries. The economy was performing poorly, which led to a reduction in the total output of the economy. Therefore, the decrease in national output meant there were reduced incomes of countries to achieve economic growth and development (Chang et al., 2013). Output declined since the labor market was not performing as a result of an increase in the rates of unemployment, and there was a reduction in the mobility of labor.

According to the Organization of Economic Cooperation of developing countries labor force survey, there was a 1% decrease in the gross domestic product with an increase in the level of unemployment in the economy (Maddison, 2007).

Political Instability in Some Countries

Countries like Greece experienced civil unrest as a result of the economic crisis in 2008. The Greek economy had shut down, and schools and airports were not functioning due to the looming global economic recession (McNally, 2011). Also, there were protests in China due to reduced exports, which led to high unemployment rates.

Decreased exports meant that Chinese companies would lay off some workers to compensate for the losses resulting from the global financial crisis and the decline in demand for Chinese goods by Western countries affected by the Great Recession.

Increased Government Intervention

In the United States, most companies were bailed out by the US government as the financial crisis heavily hit them. Also, the financial market collapsed as the value of stocks decreased, which meant companies were not performing better. The government had set aside $700 million, which could be used to bail out companies affected by the crisis.

Summary and Conclusion

To sum up, the Study shows the causes and consequences of the great recession of 2008. The failure of the financial markets caused the great depression, loose monetary policies, the search for a significant recession in the housing market, low-interest rates, and a lack of financial market regulation. The failure of the financial market was a significant cause of the Interest induction in the interest rates, which reached a level of 1%.

Also, the financial crisis was caused by global imbalances like the increase in dollar-denominated assets, as foreign companies bought American government bonds. Therefore, this made debt capital cheaper. Dollar increase opted for mortgage-backed security with low-interest rates. Furthermore, the Study shows that the financial crisis of 2008 led to a deteriorating labor market, a decline in low-international incomes due to the gross domestic product, a decline in the housing market due to reduced prices of homes, as well as instability in countries like China and Greece. Consequently, the Study shows that the Great Recession in 2008 was unfavorable to the global economy as several states were complex, and the effects like the economic shutdown in Greece and the failure of the United States Housing market heavily hit some of them.

In conclusion, to avoid future or prepare for future financial crises, there is a need to ensure stability in the commercial market. The government, policymakers, economists, and other stakeholders must develop new strategies for providing financial market stability to reduce risk exposure. Secondly, there is a need for government intervention in controlling and regulating the financial market since this would help reduce loose monetary policies like lower interest rates. Government intervention would help maintain balance and reduce financial market failure. Moreover, there is a need to evaluate the risks created by the financial crisis, like higher unemployment rates, to determine how to mitigate these issues to avoid economic sabotage in the future. Furthermore, countries need to aim to correct global imbalances that will likely affect exchange rates and the international labor market. To ensure proper function, this calls for intervention by the government and all other stakeholders and continuous research to address global economic and financial crisis issues.

References

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