Macroeconomics - Causes of 2008 Recession
Econ 111 Essay – Semester 2: 2009
The current global recession has been caused to a large degree by debt-fuelled growth in the housing market, often due to irresponsible lending practices, coupled with unregulated trading of mortgages on the bonds and derivatives markets. One of the key factors that allowed for the property bubble to expand so rapidly was the ubiquitous nature of ‘subprime’ mortgages. These were essentially loans, which generally required no deposit, that were extended regularly to people without the requisite income to pay off the debt. In an effort to fight off a recession arguably as bad the Great Depression, governments worldwide have attempted to combat growing unemployment and shrinking economies by way of massive stimulus packages. This essay will analyse the aforementioned issues surrounding the causes and severity of the current recession, governmental responses to the economic crisis, and how these responses differ from the Great Depression, in the context of relevant macroeconomic theory in order to reach an informed conclusion regarding the effectiveness of contemporary government intervention.
The subprime mortgage is widely agreed to have been the catalyst for the recession as a whole. There were, however, a number of other causes that contributed to the problem. Firstly, in the case of the USA, the Federal Reserve was slow to raise the interest rates after the US economy recovered from the 2000/01 recession. As the interest rate continued to remain low, the interest rate effect on aggregate demand encouraged greater spending on investment goods. In the case of many Americans, investment goods equated to housing and thus many took out mortgages to purchase houses purely on the basis that they could resell them for a profit. This was made possible in large part due to the prevalence of subprime loans and interest-only loans. A sub-prime mortgage is a mortgage that is given to a borrower whose credit rating would
The current global recession has been caused to a large degree by debt-fuelled growth in the housing market, often due to irresponsible lending practices, coupled with unregulated trading of mortgages on the bonds and derivatives markets. One of the key factors that allowed for the property bubble to expand so rapidly was the ubiquitous nature of ‘subprime’ mortgages. These were essentially loans, which generally required no deposit, that were extended regularly to people without the requisite income to pay off the debt. In an effort to fight off a recession arguably as bad the Great Depression, governments worldwide have attempted to combat growing unemployment and shrinking economies by way of massive stimulus packages. This essay will analyse the aforementioned issues surrounding the causes and severity of the current recession, governmental responses to the economic crisis, and how these responses differ from the Great Depression, in the context of relevant macroeconomic theory in order to reach an informed conclusion regarding the effectiveness of contemporary government intervention.
The subprime mortgage is widely agreed to have been the catalyst for the recession as a whole. There were, however, a number of other causes that contributed to the problem. Firstly, in the case of the USA, the Federal Reserve was slow to raise the interest rates after the US economy recovered from the 2000/01 recession. As the interest rate continued to remain low, the interest rate effect on aggregate demand encouraged greater spending on investment goods. In the case of many Americans, investment goods equated to housing and thus many took out mortgages to purchase houses purely on the basis that they could resell them for a profit. This was made possible in large part due to the prevalence of subprime loans and interest-only loans. A sub-prime mortgage is a mortgage that is given to a borrower whose credit rating would
References: Mankiw, N.G, (2002). Macroeconomics: Fifth Edition. New York: Worth Publishers. Garrsion, R.W, (2000). Time and money: the macroeconomics of capital structure. New York: Routledge. Vox. (2008, August). The Impact of the 2008 rebate. USA: Broda, C., & Parker, J.A (2008). Retrieved October 7, 2009, from http://www.voxeu.org/index.php?q=node/1541.