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Great recession

What Is the Great Recession?

The Great Recession refers to the severe economic downturn in the United States that officially lasted from December 2007 to June 2009. It is characterized by a significant decline in overall economic activity and is considered the longest and deepest recession since the Great Depression of the 1930s. As a critical event within the field of macroeconomics, the Great Recession had profound and lasting effects on global financial markets, housing, and employment. The period was marked by widespread job losses, plummeting asset prices, and a substantial contraction in Gross Domestic Product.

History and Origin

The origins of the Great Recession are primarily rooted in the collapse of the U.S. housing market and the subsequent financial crisis of 2008. Leading up to the recession, an extended period of loose lending standards contributed to a significant housing bubble. Financial institutions engaged in widespread subprime mortgage lending, providing loans to borrowers with poor credit histories and often without sufficient documentation or down payments. These risky mortgages were then packaged into complex financial instruments, such as mortgage-backed securities, and sold to investors globally.

As adjustable-rate mortgages reset to higher interest rates and housing prices began to decline in 2006, many homeowners found themselves unable to afford their payments, leading to a surge in foreclosures. This triggered a widespread decline in the value of mortgage-related assets, causing significant distress within the financial system. The crisis intensified in mid-2007 with a credit crunch and peaked in September 2008 with the bankruptcy of Lehman Brothers, a major investment bank. Federal Reserve Chair Ben Bernanke noted in 2010 that while subprime mortgage losses were a prominent trigger, the ensuing disruptions to a range of financial markets and institutions proved far more damaging.15

Key Takeaways

  • The Great Recession was a severe and prolonged economic downturn in the U.S. from December 2007 to June 2009.
  • It was primarily caused by the bursting of the housing bubble and a crisis in the subprime mortgage market.
  • The crisis led to widespread job losses, a sharp decline in housing values, and significant instability in global financial markets.
  • Government and central bank responses included significant monetary and fiscal interventions, as well as new financial regulations.
  • The recession highlighted vulnerabilities in the financial system, particularly concerning "too big to fail" institutions.

Interpreting the Great Recession

The Great Recession serves as a critical case study for understanding the interconnectedness of global financial markets and the potential for systemic risk. Its interpretation often focuses on the ripple effects that originated in the housing sector and propagated throughout the broader economy. The dramatic increase in the unemployment rate, which rose from 5.0 percent in December 2007 to 9.5 percent by June 2009 and peaked at 10.0 percent in October 2009, illustrates the severe human cost of the downturn.14 Analysts examine indicators such as consumer spending, industrial production, and business investment to gauge the depth and duration of the downturn and the effectiveness of policy responses. The event underscored the importance of robust financial regulation and the role of central banks in maintaining financial stability.

Hypothetical Example

Imagine a family, the Smiths, who purchased a home in 2006 with a no-money-down, adjustable-rate subprime mortgage. Their initial payments were low, but their income was unstable. As the housing bubble burst and home prices in their area dropped by 30%, their house was suddenly worth less than their mortgage balance. When their adjustable rate reset in 2008, their monthly payments skyrocketed. Unable to sell their home for enough to cover the loan or afford the higher payments, the Smiths faced foreclosure. This individual scenario multiplied across millions of households contributed to the widespread distress that characterized the Great Recession, impacting bank balance sheets and triggering a broader economic contraction.

Practical Applications

The experience of the Great Recession has shaped policy-making and risk management across various sectors. In investing, it emphasized the importance of portfolio diversification and understanding systemic risk beyond individual asset classes. For markets, the crisis prompted reforms aimed at increasing transparency and reducing leverage. Regulators implemented significant changes, notably the Dodd-Frank Act in the United States, which aimed to reform the financial system by enhancing oversight and limiting risky practices of financial institutions.12, 13 These reforms included requirements for banks to hold more capital and the establishment of new agencies like the Consumer Financial Protection Bureau (CFPB).11 Central banks, like the Federal Reserve, adopted unprecedented measures, including quantitative easing as a form of monetary policy, to provide liquidity and stimulate the economy during and after the crisis.10 The International Monetary Fund (IMF) also highlighted the crisis as a clear demonstration of the need for stronger financial surveillance and policies to address interconnectedness and systemic risks.9

Limitations and Criticisms

While the Great Recession led to significant policy changes, the effectiveness and scope of these responses have faced scrutiny. Some economists and policymakers argue that the Dodd-Frank Act, while comprehensive, did not fully address the underlying issues of "too big to fail" institutions, and that certain regulatory measures may have unintentionally stifled economic growth or innovation. Concerns have also been raised regarding the long-term impacts of unconventional monetary policies, such as expanded central bank balance sheets, on inflation and market distortions. Additionally, the initial responses were criticized for not being aggressive enough, allowing the crisis to deepen before comprehensive fiscal policy and monetary interventions were fully deployed. The protracted recovery, particularly in employment and housing, highlighted the challenges in stimulating a rapid rebound from a deep financial crisis.

Great Recession vs. Recession

The terms "Great Recession" and "Recession" are often used, but they differ significantly in scale and impact. A typical recession is generally defined by the National Bureau of Economic Research (NBER) as a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators.8 A common rule of thumb, though not official, is two consecutive quarters of negative Gross Domestic Product (GDP) growth.

The "Great Recession," however, signifies an economic downturn of exceptional depth and duration. It was the longest recession since World War II, lasting 18 months, compared to an average of 11.1 months for post-WWII recessions.7 Its severity was also far greater, marked by a larger contraction in GDP, more significant job losses, and a deeper impact on household wealth and the financial system. While all recessions involve a downturn in the business cycle, the Great Recession was uniquely characterized by its roots in a systemic financial crisis, leading to a much more widespread and challenging recovery.

FAQs

What caused the Great Recession?

The Great Recession was primarily caused by the bursting of a housing bubble fueled by lax lending standards, particularly in the subprime mortgage market, which led to a collapse in the value of mortgage-backed securities and triggered a widespread financial crisis.

How long did the Great Recession last?

The Great Recession officially lasted from December 2007 to June 2009, a period of 18 months, making it the longest U.S. recession since the Great Depression.5, 6

What were some of the key effects of the Great Recession?

Key effects included a sharp rise in the unemployment rate, a significant decline in housing prices, widespread foreclosures, and substantial instability in the global financial system.3, 4

What government actions were taken in response to the Great Recession?

In response, the U.S. government implemented large-scale fiscal stimulus packages and the Federal Reserve engaged in unprecedented monetary policy measures, such as lowering interest rates to near zero and quantitative easing. Additionally, the Dodd-Frank Act was enacted to reform financial regulation.1, 2