Great Recession

Supplementary material

Links to news reports of the key events of the recession are available on the timelines subpage, accounts of the impact of the recession on individual countries are available on the addendum subpage, and definitions of the terms employed are available in the economics glossary and the finance glossary.

Overview

The Great Recession followed a twenty-year period that has been termed the "Great Moderation", during which recessions had been less frequent and less severe than in previous periods, and during which there been a great deal of successful financial innovation. Attitudes and habits of thought acquired during that period were to have a significant influence upon what was to come. Among other significant influences were the globalisation of financial markets, with the development of large international capital flows, often from the developing to the developed economies; the large-scale granting of credit to households in some of the major economies; and the creation there of house price booms, that have since been categorised as bubbles, but were not recognised as such at the time. It struck the major economies at a time when they were suffering from the impact of a supply shock in which a surge in commodity prices was causing households to reduce their spending, and as a result of which economic forecasters were expecting a mild downturn.

The trigger that set it off was the malfunction of a part of the United States housing market that resulted in the downgrading by the credit rating agencies of large numbers of internationally-held financial assets to create what came to be known as the subprime mortgage crisis. That crisis led to the discovery that the financial innovations that had been richly rewarding traders in the financial markets, had also been threatening their collective survival. The crucial nature of that threat arose from the fact that the global economy had become dependent upon the services of a well-functioning international financial system. What was generally considered to be the impending collapse of the international financial system was averted towards the end of 2008 by widespread governmental guarantees of unlimited financial support to their countries' banks.

The consensus view among economists was that the combination of monetary and fiscal expansion that was then undertaken by policy-makers was nevertheless necessary to avoid a global catastrophe, possibly on the scale of the Great Depression of the 1930s - although there was a body of opinion at the time that considered a fiscal stimulus to be unnecessary, ineffective and potentially damaging. Before those policy actions could take effect, there were sharp reductions in the levels of activity in most of the world's developed economies, mainly because of the discovery by banks and households that they had been overestimating the value of their assets. That discovery prompted banks to reduce their lending, at first because of doubts about the reliability of the collateral offered by prospective borrowers and later, when those doubts receded, in order to avoid losing the confidence of their depositors by holding proportionately excessive amounts of debt. The practice of debt reduction (known as deleveraging) was also adopted by those households that had acquired historically high levels of indebtedness, many of whom were experiencing unaccustomed falls in the market value of their houses. The effect of deleveraging by banks and by households was, in different ways, to increase the severity of the developing recession.

By the spring of 2009, the recession had involved most of the world's developed and developing economies. The countries most affected (as noted on the addendum subpage) were those with relatively large financial sectors (chiefly the United States, the United Kingdom, Iceland and Japan), those that were affected by the downturn in world trade because of their relatively large export sectors (including Germany and Japan) and those that experienced the bursting of house price bubbles (including The United States, The United Kingdom, Ireland and Spain), and although economic growth had returned to many economies by the end of 2009, unemployment continued rising and output gap estimates revealed the continuation of substantial underutilsation of productive capacity. Governments had been forced to borrow money by issuing bonds to offset the fiscal consequences of their automatic stabilisers and their fiscal stimuluses, as a result of which there had beem substantial increases in national debt. In late 2009 and early 2010, the bond markets added several percentage points to the interest rates to be paid on the bond issues of several European governments to compensate for what was seen as a slight risk that they might default on repayment, and in 2010 the economic policies of most developed countries came to be dominated by the problem of reducing national debt without hampering recovery.

Background: the great moderation

The economy

For about twenty years before the onset of the Great Recession, all of the major market economies except Japan's had been experiencing a hitherto unaccustomed stability, following a sudden reduction of their output volatility in the mid-1980s to about a third of its previous level. It was not clear at the time whether the "Great Stability", as it came to be called, should be attributed to to luck or to judgement, but the US Federal Reserve's Ben Bernanke has been inclined to attribute it to the adoption of an economic policy , referred to by others in America as the "Greenspan effect", and Charles Bean (the Deputy Governor of the Bank of England) has described the transition from what had been thought of as the Keynesian use of fiscal policy - through the unsuccessful monetarist attempts to target the money supply, to what he refers to as "the neo-classical synthesis" or as "new Keynesian", under which monetary policy was targetted on the output gap using an empirical relationship such as the Taylor rule.