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| Supplements to this article include an annotated[[/Timelines|''' chronology ''']] of the main events of the recession; and  accounts of the  [[/Addendum| '''regional impact''']] of the recession.  
| In addition to the text below, this article consists of  an annotated[[/Timelines|''' chronology ''']] of the main events of the recession; and  accounts of the  [[/Addendum| '''regional impact''']] of the recession.<br> It was last updated on 26 February 2013.  
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In their 2010 report, the  Economic Advisors to the President referred  the recent economic downturn as the '''Great Recession''', suggesting a parallel with the Great Depression of the 1930s. Like the Great Depression - and unlike other recessions - it had a simultaneous impact on most of the world's economies. But in other respects it was unique. There had been no precedent for such extensive damage to the world's financial system, nor for the coordinated  measures that were taken to avert what was feared to be its imminent collapse.  
The '''Great Recession'''<ref>The term ''Great Recession'' was used in the 2010 report to the President of the United States by his Council of Economic Advisers[http://www.nber.org/erp/2010_erp.pdf], and has since become colloquial].</ref> occurred against a background of [[Banking#Deregulation|financial deregulation]] and [[Crash of 2008#Financial innovation|financial innovation]], and of [[Subprime mortgage crisis#International capital flows| capital flows]] from developing to developed economies. Its precursors  were sharp increases in global food and oil prices, a [[subprime mortgage crisis|housing market breakdown]] in the United States, and a related [[crash of 2008|global banking panic]].  


Although, according to the generally accepted definition of the term, the [[recession]] ended in most countries when economic growth resumed during 2009, its damaging effects upon the major economies are expected to persist beyond 2011, and its ultimate  cost may amount to as much as a whole year's ouput of every country in the world.  
Its categorisation as "great" was prompted by the fact that it was  the first [[recession]] to involve a reduction in the recorded economic activity of the world as a whole. Every major economy was affected. The developed economies experienced contractions, and the developing economies experienced reductions in their  growth rates.  In many of the developed economies it also developed the (almost) unprecedented  character of a [[balance sheet recession]]in which banks use [[deposit (banking)|deposits]] to rebuild [[reserves (banking)|reserves]], rather than to give [[credit (finance)|credit]], and households use income to pay off [[debt]] rather than to make purchases.  


The Great Recession has prompted a re-examination of beliefs concerning the functioning of [[markets]] comparable to that which followed the Great Depression.
The trough of the Great Recession occurred mostly in 2009. A global recovery was  under way in 2010, but it was hampered by the [[deleveraging]] effects of balance sheet crises, and by  [[Shock (economics)|economic shock]]s including the [[tsunami|Japanese tsunami]] of March 2011, and by [[contagion (finance)|contagion]] from  the [[eurozone crisis]]. In most developed economies, the operation of their economies' [[automatic stabilisers]] had the effect of driving the [[public debt]] to unprecedented peace-time levels, prompting the introduction of [[austerity (fiscal)|austerity programmes ]] designed to restore investor confidence in the [[fiscal sustainability|sustainability]] of their [[fiscal policy|fiscal policies]]. 
A substantial amount of [[output gap|unused capacity]]  persisted through 2012 and into 2013.


==Introduction==
==Introduction==
Explanations of the causes of the recession and  accounts of contemporary debates concerning policy responses are available in the articles on the [[subprime mortgage crisis]], the [[crash of 2008]] and the [[recession of 2009]], together with  timelines linked to contemporary reports.
This article is  the fourth of a series of contemporary accounts of financial and economic events and developments during the period from mid 2007 to the end of 2011. The other articles are:-
:[[Subprime mortgage crisis]] - events surrounding the bursting of a house price [[bubble (economics)|bubble]] in the United States in mid 2007;
:[[Crash of 2008]] - global financial developments from mid 2007 to the end of 2008;
:[[Recession of 2009]] - global economic developments from mid 2007 to the end of 2010


==Overview==
==Overview==
During the 1980s there was a widespread re-appraisal of the regulations that had been introduced in response to the financial instability that developed during  the [[Great Depression]]. A consensus had already emerged that many  regulations were economically harmful, as a result of which programmes of deregulation had been adopted. The reappraisal concluded that the financial regulations of the 1930s had become unnecessary because recently-developed [[monetary policy]]  could be used to counter any further signs of instability. Ongoing programmes of[[Banking#Deregulation| banking deregulation]] that had prevented [[investment bank]]s  from engaging in branch banking, insurance or [[mortgage]] lending were dropped, and [[reserve ratio|reserve]] requirements were relaxed or removed.   
During the 1980s there was a widespread re-appraisal of the regulations that had been introduced in response to the financial instability that developed during  the [[Great Depression]]. It was concluded that the financial regulations of the 1930s had become unnecessary because recently-developed [[monetary policy]]  could be used to counter any further signs of instability. Ongoing programmes of[[Banking#Deregulation| banking deregulation]] that had prevented [[investment bank]]s  from engaging in branch banking, insurance or [[mortgage]] lending were dropped, and [[reserve ratio|reserve]] requirements were relaxed or removed.   


After the mid-1980s came  a twenty-year  period that has been termed the [[great moderation]], during which [[recession]]s had been less frequent and less severe than in previous periods, and during which there  been  a great deal of successful  [[banking#The 20th century|financial innovation]].  
After the mid-1980s came  a twenty-year  period that has been termed the [[great moderation]], during which [[recession]]s had been less frequent and less severe than in previous periods, and during which there  been  a great deal of successful  [[banking#The consequences of the banking innovations |financial innovation]].


In the United States, that period was characterised by massive capital inflows and the large-scale availability of [[credit (finance)|credit]] to households,  and by  2007 personal [[savings ratio|savings rates]] dropped to 2 per cent of [[disposable income]] from their previous average of 9 per cent and there was a house price boom  that has since been categorised as a [[Asset price bubble|bubble]].  
In the United States, that period was characterised by massive capital inflows, and the large-scale availability of [[credit (finance)|credit]] to households. By  2007, their personal [[savings ratio|savings rates]] had dropped to 2 per cent of [[disposable income]] from their previous average of 9 per cent and there was a house price boom  that has since been categorised as a [[Asset price bubble|bubble]]. The bursting of that bubble in 2007, and the downgrading by the [[credit rating  agency|credit rating agencies]] of large numbers of internationally-held [[asset (finance)|financial assets]]  created what came to be known as the [[subprime mortgage crisis]], which led, in turn,  to a [[crash of 2008#The crisis|global financial crisis]] involving the failure of several of the world's largest banks.   
The bursting of that bubble in 2007, and the downgrading by the [[credit rating  agency|credit rating agencies]] of large numbers of internationally-held [[asset (finance)|financial assets]]  created what came to be known as the [[subprime mortgage crisis]], which led, in turn,  to the  financial [[crash of 2008]] and the failure of several of the world's largest banks.  The loss of investors' confidence caused by  failure of the ''Lehman Brothers'' [[investment bank]] in September 2008,  resulted in a [[credit crunch]]. The resulting fall in spending struck the major economies at a time when they were already suffering from the impact of a [[supply shock (economics)|supply shock]] in which  a surge in commodity prices was causing households to reduce their spending. Economic forecasters had been  expecting a mild [[Downturn (economic)|downturn]]: what actually happened  was the global slump in ecomomic activity that has come to be known as the Great Recession.
In September 2008, the loss of investors' confidence caused by  failure of the ''Lehman Brothers'' [[investment bank]] resulted in the curtailing of financial activity on a scale that amounted almost to the collapse of  the global financial  system. Its total collapse was averted towards the end of 2008 by [[crash of 2008/Timelines#Systemic rescue measures|systemic rescue measures]] that included the general recapitalisation of the  banks and guarantees of unlimited financial support. The global banking system remained in a fragile condition, however, as a result of its discovery of the need to
[[writedown (accounting)|writedown]] the value of its [[asset (banking)|assets]] because of their inclusion of substantial amounts of [[toxic debt]]. The effect of that discovery was their realisation of the need for [[deleveraging]] (in order to limit their [[banking/Tutorials#The arithmetic of leverage|leverage risks]]), and of the consequent need to limit their lending. The result was a reduction in the supply of [[credit (finance)|credit]] to households and businesses that became known as a [[credit crunch]].  


Although the  trigger that set the recession  off had been the malfunction of a part of the United States  housing market, it soon emerged that a more fundamental problem had been  the fact  that the [[banking#The 20th century|financial innovations]] that had been  richly rewarding traders in the world's financial marketshad also  been threatening their collective survival. The  crucial nature of that threat for the stability of the world economy  arose from the fact that it had become dependent upon the services of a well-functioning international [[financial system]].  
The effect of the  credit crunch, on top of an earlier surge in oil and commdity prices, was a reduction in consumption and investment. Despite the launching of numerous national programmes of fiscal and monetary expansion, the result was a fall in global economic activity in which the world's developing economies experienced reductions in their growth, and its developed economies experienced periods of negative growth.  


What was generally considered to be the impending collapse of that system was averted towards the end of 2008 by  governmental recapitalisation of the world's banks, backed up by guarantees of unlimited financial support. The consensus view among economists was that the combination of [[monetary policy|monetary]] and [[fiscal policy|fiscal]] expansion that was then undertaken by policy-makers was nevertheless  necessary to avoid  a  greatly intensified global [[recession]], 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<ref>[http://www.iea.org.uk/record.jsp?type=pressArticle&ID=376 ''Keynesian Over-spending Won't Rescue the Economy", Letter by IEA economists in the Sunday Telegraph, 26 October 2008]</ref>. 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 (finance)|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 end of 2009, growth had resumed in most of the world's economies, but pre-crisis growth rates were not restored except among emerging and developing economies. Growth among the developed economies was generally held back by the lasting damage that had been done to their financial sectors, and by the expenditure effects of reductions in household debt. Consequently there was continued underutilisation of productive capacity and unemployment continued to riseMany governments had been forced to borrow money by issuing [[bond]]s, to offset the fiscal consequences of their  [[automatic stabilisers]], as a result of which there had been major increases in [[national debt]].  


By the spring  of 2009, the recession had involved most of the world's developed and developing economies,  and although the world's economic growth had resumed by end of 2009, pre-crisis growth rates were not restored except among emerging and developing economies. Growth among the  developed economies was generally held back by the lasting damage that had been done to their financial sectors, and by the expenditure effects of reductions in household debt. Consequently there was continued underutilisation of productive capacity and unemployment continued to riseMany governments had been forced to borrow money by issuing [[bond]]s, to offset the fiscal consequences of their  [[automatic stabilisers]], as a result of which there had been major increases in [[national debt]]. In late 2009 and early 2010, the [[bond]]  markets added substantial [[risk premium]]s to the interest rates to be paid on the bond issues of several European governments to compensate for fears of  [[default (finance)|default]] on their repayment.  
The recovery continued throughout 2010, but by its third quarter, the effects of [[fiscal stimulus]]es had peaked in most of the developed economies. Despite the persistence of unused capacity, European governments were generally reluctant to provide further fiscal support for fear of adverse market reactions to the bond issues that would be requiredIn response to that fear, European governments reduced their  [[public expenditure]] plans and increased taxation. The Government of the --------United States, on the other hand, continued its policy of [[fiscal policy|fiscal]] and [[monetary policy|monetary]] expansion. The indebtedness of the  governments of Greece and Ireland  rose to unsustainable levels, and a [[eurozone crisis]] began to develop as conditional eurozone "bailout" loans failed to reassure investors in their bonds.  


By the third quarter  of 2010 the effects of [[fiscal stimulus]]es had peaked in most of the developed economies. Despite the persistence of unused capacity, European governments were generally reluctant to provide further fiscal support for fear of adverse market reactions to the bond issues that would be required.  In response to that fear, European governments reduced their  [[public expenditure]] plans and increased taxation. The Government of the United States, on the other hand, continued its policy of [[fiscal policy|fiscal]] and [[monetary policy|monetary]] expansion. A [[eurozone crisis]] developed as financial assistance to the governments of Greece and Ireland failed to reassure bond market investors. The world economy as a whole experienced vigorous growth during the first half of 2011, but the cumulative effect of a series of [[shock (economics)|shocks]] had a damaging effect upon confidence, and fears of a return to recession affected markets during the third quarter of the year. Growth of the developed economies nevertheless remained slow and hesitant, and the OECD  estimated that the 2011 [[output gap]] for the OECD economies was over 3 per cent.
During the first half of 2011, the world economy as a whole experienced vigorous growth , but  the growth of the developed economies remained slow and hesitant. In the course of 2011 the confidence of investors and households was damaged by  a series of [[shock (economics)|shocks]], and by the continuing failure of the authorities to resolve an expanding eurozone crisis. There was a decline in the growth rates of most European economies. and signs of [[contagion (finance)|contagion]] from the [[eurozone crisis]] to economies outside Europe.


==Background: the great moderation (1985 - 2007)==
==Background: the great moderation (1985 - 2007)==
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===Financial innovation===
===Financial innovation===
The reduction that took place in  the yields on government bonds prompted investors to seek higher-yielding alternatives, and the finance industry employed a great deal of high-powered ingenuity to meet that demand. They were helped in that endeavour  by a series of Nobel-prize-winning advances in [[financial economics]] that had been made in the 1970s and early 1980s; by the [[banking#Deregulation|deregulations]] of the 1980s, and the work of a group of brilliant mathematicians that came to be known as the "quants"<ref> Scott Patterson: ''The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It'', Random House 2010</ref>. The economists had developed a succession of theories based upon adaptations of the [[financial economics#The efficient market hypothesis|the efficient market hypothesis]], including [[financial economics#Risk limitation|portfolio theory]] and the [[financial economics#Equity pricing|capital asset pricing model]]; on the basis of which the quants developed and operated a range of computer packages that could provide precise estimates of an investor's  [[financial economics#The problems facing the financial intermediaries|"value at risk"]] derived from probability analysis of previous experience.
The reduction that took place in  the yields on government bonds prompted investors to seek higher-yielding alternatives, and the finance industry employed a great deal of high-powered ingenuity to meet that demand. They were helped in that endeavour, firstly by a series of Nobel-prize-winning advances in [[financial economics]] that had been made in the 1970s and early 1980s; secondly by the [[banking#Deregulation|deregulations]] of the 1980s, and thirdly by the work of a group of brilliant mathematicians that came to be known as the "quants"<ref> Scott Patterson: ''The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It'', Random House 2010</ref>. The economists had developed a succession of theories based upon adaptations of the [[financial economics#The efficient market hypothesis|efficient market hypothesis]], including [[financial economics#Risk limitation|portfolio theory]] and the [[financial economics#Equity pricing|capital asset pricing model]]; on the basis of which the quants developed and operated a range of computer packages that could provide precise estimates of an investor's  [[financial economics#The problems facing the financial intermediaries|"value at risk"]] derived from probability analysis of previous experience.
Armed with more sophisticated methods of assessing risk, the banks and other [[Financial Intermediary|financial intermediaries]] increased their capacity to provide [[credit (finance)|credit]] to producers and consumers by distributing the risks and rewards involved more widely among those most willing to accept them. The devices adopted for that purpose included a vastly extended application of the techniques of [[securitisation]], involving the conversion of their loans into  packages of [[bond]]s that were graded according to the  [[credit risk]] ratings provided by the [[credit rating agency|credit rating agencies]]. The traditional banking practice of holding loans on their balance sheets until they were repaid,  gave way to  the strategy known as [[originate and distribute]], under which  those packages of  bonds were sold  to pension funds, insurance companies and other banks. That procedure removed the loans from the balance sheets of the banks, and the institutions of the growing [[shadow banking system]], thus enabling them to increase activity without breaching the [[reserve ratio]] requirements of the [[financial regulator|financial regulators]].
Armed with more sophisticated methods of assessing risk, the banks and other [[Financial Intermediary|financial intermediaries]] increased their capacity to provide [[credit (finance)|credit]] to producers and consumers by distributing the risks and rewards involved more widely among those most willing to accept them. The devices adopted for that purpose included a vastly extended application of the techniques of [[securitisation]], involving the conversion of their loans into  packages of [[bond]]s that were graded according to the  [[credit risk]] ratings provided by the [[credit rating agency|credit rating agencies]]. The traditional banking practice of holding loans on their balance sheets until they were repaid,  gave way to  the strategy known as [[originate and distribute]], under which  those packages of  bonds were sold  to pension funds, insurance companies and other banks. That procedure removed the loans from the balance sheets of the banks, and the institutions of the growing [[shadow banking system]], thus enabling them to increase activity without breaching the [[reserve ratio]] requirements of the [[financial regulator|financial regulators]].


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What came to be known as the [[subprime mortgage crisis]] had its origin in repayment [[default (finance)|defaults]] by some Americans with low [[credit rating agency|credit ratings]] who had borrowed money to help pay for house purchases.  When house prices were rising,  many of them had been able to get the money needed for repayments by further borrowing (because of the increased [[collateral (finance)|collateral]] that the price increases enabled them to offer). But the  sharp fall in the market value of their houses that occurred in  2007 deprived them of that option, and left many of them owing more than their houses were worth  - making default a rational, and sometimes unavoidable, recourse.  
What came to be known as the [[subprime mortgage crisis]] had its origin in repayment [[default (finance)|defaults]] by some Americans with low [[credit rating agency|credit ratings]] who had borrowed money to help pay for house purchases.  When house prices were rising,  many of them had been able to get the money needed for repayments by further borrowing (because of the increased [[collateral (finance)|collateral]] that the price increases enabled them to offer). But the  sharp fall in the market value of their houses that occurred in  2007 deprived them of that option, and left many of them owing more than their houses were worth  - making default a rational, and sometimes unavoidable, recourse.  


The financial crisis began in early June 2007, when  surge in [[default (finance)|defaults]]  led the [[credit rating agency|credit rating agencies]] to downgrade their ratings of [[security (finance)|securities]] based upon those [[mortgage]]s, and banks holding such securities found themselves unable to use them as [[collateral (finance)|collateral]] for their borrowing needs. This created  financial problems that started with [[Fannie Mae]] and [[Freddie Mac]] and then shifted to the major banks <ref>[http://www.bankofengland.co.uk/publications/fsr/2008/index.htm ''Financial Stability Report'', pages 18 & 19, Bank of England October 28 2008]</ref>. In that month, [[hedge fund]]s guaranteed by the American ''Bear Stearns'' bank  ran into difficulties, and [[mortgage]] [[default (finance)| defaults]] led subsequently to the collapse - and a government rescue from [[bankruptcy]] - of the government-sponsored mortgage lenders [[Fannie Mae]] and [[Freddie Mac]].  Uncertainty about the quality of banking [[asset (finance)|assets]]  made banks reluctant to lend to each other and the important [[interbank market]] vitually ceased to operate, triggering  a [[credit] (finance)|credit]] shortage.
The financial crisis began in early June 2007, when  surge in [[default (finance)|defaults]]  led the [[credit rating agency|credit rating agencies]] to downgrade their ratings of [[security (finance)|securities]] based upon those [[mortgage]]s, and banks holding such securities found themselves unable to use them as [[collateral (finance)|collateral]] for their borrowing needs. This created  financial problems that started with the government-sponsored mortgage lenders [[Fannie Mae]] and [[Freddie Mac]] and then shifted to the major banks <ref>[http://www.bankofengland.co.uk/publications/fsr/2008/index.htm ''Financial Stability Report'', pages 18 & 19, Bank of England October 28 2008]</ref>. In that month, [[hedge fund]]s guaranteed by the American ''Bear Stearns'' bank  ran into difficulties, and [[mortgage]] [[default (finance)| defaults]] led subsequently to the collapse - and a government rescue from [[bankruptcy]] of [[Fannie Mae]] and [[Freddie Mac]].  Uncertainty about the quality of banking [[asset (finance)|assets]]  made banks reluctant to lend to each other and the important [[interbank market]] virtually ceased to operate, triggering  a [[credit (finance)|credit]] shortage.
 
 
The events of 9th August 2007 marked the  first upsurge in  the intensity  of the crisis. The  French bank ''BNP Paribas'' announced  that it had suspended withdrawals from three of its [[hedge fund]]s on the grounds that it had become impossible to value their mortgage-backed assets. On the same day it  became apparent that European banks were experiencing serious [[liquidity]] shortages when it was learned that they had sought help from the [[European Central Bank]]. Other banks throughout the world cut back on their lending in an attempt to offset the  increase in their [[leverage]] brought about by the downgrading of their mortgage-based assets. The fear of default  fed on itself as a result of  more and more  [[Bank failures and rescues/Timelines#2007| major bank failures in 2007]] [[Bank failures and rescues/Timelines#2008|and 2008]] as well as many failures of other businesses - often because they found themselves unable to [[roll-over]] their debts. In March 2008 the United States authorities organised the rescue of the ''Bear Stearns'' (the world's fifth largest [[investment bank]])].
The events of 9th August 2007 marked the  first upsurge in  the intensity  of the crisis. The  French bank ''BNP Paribas'' announced  that it had suspended withdrawals from three of its [[hedge fund]]s on the grounds that it had become impossible to value their mortgage-backed assets. On the same day it  became apparent that European banks were experiencing serious [[liquidity]] shortages when it was learned that they had sought help from the [[European Central Bank]]. Other banks throughout the world cut back on their lending in an attempt to offset the  increase in their [[leverage]] brought about by the downgrading of their mortgage-based assets. The fear of default  fed on itself as a result of  more and more  [[Bank failures and rescues/Timelines#2007| major bank failures in 2007]] [[Bank failures and rescues/Timelines#2008|and 2008]] as well as many failures of other businesses - often because they found themselves unable to [[roll-over]] their debts. In March 2008 the United States authorities organised the rescue of the ''Bear Stearns'' (the world's fifth largest [[investment bank]])].


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==Policy response (2008 - 2009)==
==Policy response (2008 - 2009)==
===Financial policy===
===Financial policy===
In the course of the first two weeks of October 2008 a series of [[/Timelines#Financial policy|banking systems rescue plans]] had been launched<ref> "A chronology of policy responses to the financial market crisis", Appendx A.1A, OECD Economic Outlook, December 2008</ref>. The UK had announced large scale plans to inject capital into its banks and to offer unlimited guarantees on the debts of all of its banks, and similar action had shortly after been agreed by European leaders and by  the President of the United States. The [[Bank failures and rescues/Addendum#Banking rescues in the recession of 2009|national rescue systems]] that were actually adopted by the principal banking countries differed only in detail from those initial proposals. It was  recognised that those actions were temporary treatments, not remedies, and remedial measures were also set in motion in the course of 2009, as described in the paragraph below on [[#Diagnosis and remedies|diagnosis and remedies]].
In the course of the first two weeks of October 2008 a series of [[/Timelines#Financial policy|banking systems rescue plans]] had been launched<ref> "A chronology of policy responses to the financial market crisis", Appendix A.1A, OECD Economic Outlook, December 2008</ref>. The UK had announced large scale plans to inject capital into its banks and to offer unlimited guarantees on the debts of all of its banks, and similar action had shortly after been agreed by European leaders and by  the President of the United States. The [[Bank failures and rescues/Addendum#Banking rescues in the recession of 2009|national rescue systems]] that were actually adopted by the principal banking countries differed only in detail from those initial proposals. It was  recognised that those actions were temporary treatments, not remedies, and remedial measures were also set in motion in the course of 2009, as described in the paragraph below on [[#Diagnosis and remedies|diagnosis and remedies]].


===Monetary policy===
===Monetary policy===
The [[Federal Reserve System|Federal Reserve Bank]], the Bank of Japan and the [[Bank of England made a series of  [[discount rate]] reductions  to near zero levels in the 4th quarter of 2008 and the 1st quarter of 2009 (and the [[European Central Bank]] made a series of reductions to reach 1 per cent in the 2nd quarter. When it became clear that those moves had not achieved the intended easing of the [[credit crunch]] it was decided to adopt the controversial and largely untried  policy of [[quantitative easing]].
The [[Federal Reserve System|Federal Reserve Bank]], the Bank of Japan and the [[Bank of England]] made a series of  [[discount rate]] reductions  to near zero levels in the 4th quarter of 2008 and the 1st quarter of 2009 (and the [[European Central Bank]] made a series of reductions to reach 1 per cent in the 2nd quarter. When it became clear that those moves had not achieved the intended easing of the [[credit crunch]] it was decided to adopt the controversial and largely untried  policy of [[quantitative easing]].


===Fiscal policy===
===Fiscal policy===
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Regional impacts varied widely, however. There was little change to the economies of  Southern Asia; those of East Asia  were less adversely affected  than most; the economies of [[/Addendum#China|China]] and [[/Addendum#India|India]]  experienced  significant growth rate reductions; and all the high-income economies of [[/Addendum#The United States|the United States]], [[/Addendum#Europe|Europe]] and [[/Addendum#Japan|Japan]], together with most of the other developing countries, went into [[recession]]. The severest effects were upon the economies of [[/Addendum#Russia|Russia]], the [[/Addendum#The Baltic States|Baltic States]], [[/Addendum#Iceland|Iceland]] and [[/Addendum#Ireland|Ireland]]. There were widespread increases in unemployment.
Regional impacts varied widely, however. There was little change to the economies of  Southern Asia; those of East Asia  were less adversely affected  than most; the economies of [[/Addendum#China|China]] and [[/Addendum#India|India]]  experienced  significant growth rate reductions; and all the high-income economies of [[/Addendum#The United States|the United States]], [[/Addendum#Europe|Europe]] and [[/Addendum#Japan|Japan]], together with most of the other developing countries, went into [[recession]]. The severest effects were upon the economies of [[/Addendum#Russia|Russia]], the [[/Addendum#The Baltic States|Baltic States]], [[/Addendum#Iceland|Iceland]] and [[/Addendum#Ireland|Ireland]]. There were widespread increases in unemployment.


The  recession had struck widely for reasons that often had  nothing in common with the events that set it off.  Economies with relatively large financial sectors - such as those of [[/Addendum#The United Kingdom|Britain]] and [[/Addendum#Iceland|Iceland]] - suffered directly from the banking crisis. Economies with relatively large export sectors - such as those of [[/Addendum#Japan|Japan]] and [[/Addendum#Germany|Germany]] and many developing countries - suffered indirectly from the [[Recession of 2009/Addendum#World trade| collapse in world trade]] that occurred at the end of 2008<ref>[http://www.oecdilibrary.org/docserver/download/fulltext/5ks8bdvm8g42.pdf?expires=1272002338&id=0000&accname=freeContent&checksum=B012DCA2FA8A878D8E6C481A540D6179 Cheung, C. and S. Guichard: ''Understanding the World Trade Collapse'', OECD Economics Department Working Papers, No. 729, OECD Publishing, October 2009]</ref>.  Commodity-exporting  countries in [[/Addendum#Africa|Africa]] and [[/Addendum#Central and South America|Central and South America]] were affected by the [[Recession of 2009/Addendum#Commodity prices|fall in commodity prices]], the fall in the [[Recession of 2009/Addendum#The oil price|oil price]] hit the oil- exporting countries such as Russia and Mexico, and the international [[credit crunch]] created financial problems for [[/Addendum#Developing countries excluding China and India|developing countries]] who found themselves unable to [[roll-over]] maturing short-term debt.  In several countries,  (including the [[/Addendum#United States|United States]], the United Kingdom and Ireland ) the recession had the historically rare characteristics of a [[balance sheet recession]]<ref>[http://www.house.gov/apps/list/hearing/financialsvcs_dem/richardc.koo.pdf Richard C. Koo:  ''U.S. Economy in Balance Sheet Recession: What the U.S. Can Learn from Japan’s Experience in 1990–2005'', Testimony to the House of Representatives Financial Services Committee, 10th February 2010]</ref>, which they suffered as a  result of the acquisition of [[toxic debt]] from the American [[subprime mortgage crisis]]. In the United States, Japan and the United Kingdom, the effect of [[deleveraging]] by the banks was accentuated  by attempts by businesses and households to reduce their [[Recession of 2009/Addendum#Total debt|inflated levels of debt]].
The  recession had struck widely for reasons that often had  nothing in common with the events that set it off.  Economies with relatively large financial sectors - such as those of [[/Addendum#The United Kingdom|Britain]] and [[/Addendum#Iceland|Iceland]] - suffered directly from the banking crisis. Economies with relatively large export sectors - such as those of [[/Addendum#Japan|Japan]] and [[/Addendum#Germany|Germany]] and many developing countries - suffered indirectly from the [[Recession of 2009/Addendum#World trade| collapse in world trade]] that occurred at the end of 2008<ref>[http://www.oecdilibrary.org/docserver/download/fulltext/5ks8bdvm8g42.pdf?expires=1272002338&id=0000&accname=freeContent&checksum=B012DCA2FA8A878D8E6C481A540D6179 Cheung, C. and S. Guichard: ''Understanding the World Trade Collapse'', OECD Economics Department Working Papers, No. 729, OECD Publishing, October 2009]</ref>.  Commodity-exporting  countries in [[/Addendum#Africa|Africa]] and [[/Addendum#Central and South America|Central and South America]] were affected by the [[Recession of 2009/Addendum#Commodity prices|fall in commodity prices]], the fall in the [[Recession of 2009/Addendum#The oil price|oil price]] hit the oil- exporting countries such as Russia and Mexico, and the international [[credit crunch]] created financial problems for [[/Addendum#Developing countries excluding China and India|developing countries]] who found themselves unable to [[roll-over]] maturing short-term debt.  In several countries,  (including the [[/Addendum#United States|United States]], the United Kingdom and Ireland ) the recession had the historically rare characteristics of a [[balance sheet recession]]<ref>[http://archives.financialservices.house.gov/media/file/hearings/111/richardc.koo.pdf Richard C. Koo:  ''U.S. Economy in Balance Sheet Recession: What the U.S. Can Learn from Japan’s Experience in 1990–2005'', Testimony to the House of Representatives Financial Services Committee, 10th February 2010]</ref>, which they suffered as a  result of the acquisition of [[toxic debt]] from the American [[subprime mortgage crisis]]. In the United States, Japan and the United Kingdom, the effect of [[deleveraging]] by the banks was accentuated  by attempts by businesses and households to reduce their [[Recession of 2009/Addendum#Total debt|inflated levels of debt]].
 
==Fiscal aftermath (2009-13 )==
As the recovery got under way, policy-makers were faced by the [[fiscal policy/Tutorials#The fiscal dilemma|fiscal dilemma]], that arose from the conflict been the wish to reduce  their recession-inflated [[public debt]] and the wish to avoid creating another [[downturn  (economic)|downturn]]. In October 2009, the [[International Monetary Fund]] had advised that, notwithstanding rising public debt in many countries, [[fiscal stimulus]]es needed  to be sustained until the recovery is on a firmer footing and may even need to be extended, but that it could lose its effectiveness in the absence of convincing reassurances to investors  that government  debt will eventually be rolled back<ref>[http://www.imf.org/external/pubs/ft/weo/2009/02/pdf/text.pdf. ''Sustaining the Recovery'', World Economic Outlook, International Monetary Fund, October 2009]</ref>. During the early months of 2010, national authorities in most of the developed countries  became concerned  that operators in the bond markets might demand the addition of  substantial  [[risk premium]]s to the normal rates of return on new issues of government bonds. In the event, the [[yield (finance)|yield]]s on the government [[bond (finance)| bonds]] of the developed countries fell to record lows<ref>[http://citywire.co.uk/money/government-bond-yields-sink-to-record-lows-on-double-dip-fears/a425848 James Phillipps: ''Government bond yields sink to record lows on double dip fears'', Citywire, 25 August 2010]</ref> (except those of the [[PIIGS]] countries<ref>[https://news.fxpro.com/news/view_news/4528 ''PIGS bonds under huge strain again'', FXpro 26 August 2010]</ref>), substantially improving the [[fiscal sustainability|sustainability]] of their [[public debt|debt]]. In Europe, a consensus nevertheless developed in favour of allowing the [[fiscal stimulus|fiscal stimuluses]] of 2009 to lapse, and to adopt plans for the rapid reduction of [[budget deficit]]s; and [[G20]] leaders resolved to halve their deficits by 2013<ref>[http://www.g20.org/Documents/g20_declaration_en.pdf. G20 Summit Declaration, July 27 2010]</ref>.  A different view was taken by the United States government. Treasury Secretary Geithner argued that an immediate deficit reduction would inhibit economic recovery<ref>[http://www.bbc.co.uk/news/business-12307906 ''Davos 2011: Geithner resists pressure for drastic cuts'', BBC News January 28 2011]</ref>, and a budget programme was  adopted that would increase the country's budget deficit to its highest proportion of GDP in its history<ref>[http://www.cbo.gov/ftpdocs/120xx/doc12039/SummaryforWeb.pdf ''The Budget and Economic Outlook: Fiscal Years 2011 to 2021'', Congressional Budget Office, January 2011]</ref>.
During 2010, a [[eurozone crisis]] developed as investors became increasingly reluctant to buy the  [[bond]]s isued by  the governments of Greece, Ireland and Portugal,  and the governments concerned had to make a succession of interest rate increases in order to [[roll-over]] maturing debt.  The  governments concerned eventually decided that, without help,  they  would not be able to continue to  finance their budget deficits,  and they sought - and received - loans from other European governments. Those measures failed to reassure the bond market, and  there were continuing increases in their [[spread (finance)|yield spreads]] over German bonds.


==Economic Recovery (2009-2011)==
==Economic Recovery (2009-2011)==
Early in 2009 there were signs of a  gradual return of confidence in operation of the financial system. There was no longer a prospect of the collapse of the financial system, but nor was there an immediate prospect of a return to normal. Bank executives were by then acutely aware of the need to reduce [[leverage]] and were devoting available funds to that purpose rather than to lending. As a result there was no more than a gradual reduction in the severity of the [[credit crunch]]
<ref>[http://www.bankofengland.co.uk/publications/fsr/2009/fsrfull0906.pdf. ''Financial Stability Report'', Bank of England, June 2009]</ref>. There were also  signs of a return to the growth of economic activity. World output rose at 3¼ per cent per annum in the second quarter of 2009, and  at 4½ per cent in the second half as a whole. Most of the growth occurred in the emerging economies. In the developed economies, the pace of recovery was slow, and activity remained far below precrisis levels. Growth was led by a rebound in manufacturing and the rebuilding of depleted inventories<ref>[http://www.imf.org/external/pubs/ft/weo/2009/02/pdf/c1.pdf ''World Economic Outlook'', International Monetary Fund October 2009]</ref>.  By the middle of 2009 the [[Recession of 2009/Addendum#World trade|world trade statistics]] were  also showing signs of a recovery, and  growth  continued through the second half of 2009 and into the first quarter of 2010, although the volume of trade remained substantially below pre-recession levels<ref>[http://www.oecd.org/dataoecd/52/38/45684950.pdf ''OECD International Trade Statistics, News release, 21 July 2010'']]</ref>.


Early in 2009 there were signs of a  gradual return of confidence in operation of the financial system. By February, [[LIBOR-OIS spread]]s had fallen from their 3½ per cent peak to around 1 percent, and by August they had return to the relatively normal level of 0.25 per cent. There was no longer a prospect of the collapse of the financial system, but nor was there an immediate prospect of a return to normal. Bank executives were by then accutely aware of the need to reduce [[leverage]] and were devoting available funds to that purpose rather than to lending. As a result there was no more than a gradual reduction in the severity of the [[credit crunch]]
By the beginning of 2010, most economies had returned to economic growth, but the recession continued into 2010 in the [[/Addendum#The Baltic States|Baltic States]], [[/Addendum#Ireland|Ireland]], [[/Addendum#Greece|Greece]] and [[/Addendum#Spain|Spain]]. Vigorous economic growth returned to the emerging economies in the Far East, but growth of the mature economies remained well below trend through 2010, leaving substantial [[output gap]]s unclosed. Nevertheless  the world economy as a whole  experienced over 5 per cent growth in 2010, with the growth rates of many developing economies having returned to pre-recession levels<ref>[http://www.imf.org/external/pubs/ft/weo/2011/02/pdf/text.pdf ''World Economic Outlook Projections'', International Monetary Fund, September 2011, Table 1.1.]</ref>.
<ref>[http://www.bankofengland.co.uk/publications/fsr/2009/fsrfull0906.pdf. ''Financial Stability Report'', Bank of England, June 2009]</ref>


There were also  signs of a return to the growth of economic activity. World output rose at 3¼ per cent per annum in the second quarter of 2009, and  at 4½ per cent in the second half as a whole. Most of the growth occurred in the emerging economies. In the developed economies, the pace of recovery was slow, and activity remained far below precrisis levels. Growth was led by a rebound in manufacturing and the rebuilding of depleted stocks<ref>[http://www.imf.org/external/pubs/ft/weo/2009/02/pdf/c1.pdf ''World Economic Outlook'', International Monetary Fund October 2009]</ref>.  Estimates of [[output gap]]s<ref>[http://www.economywatch.com/economic-statistics/economic-indicators/Output_Gap_Percent_of_Potential_GDP/ ''Output Gap, Percent of Potential GDP Data for All Countries, Economy Watch, January 2010]</ref>   indicated the presence in most developed countries of very substantial amounts of unused resources suggesting that without a high degree of labour market [[price flexibility]], high levels of unemployment would probably  persist into  2010 and beyond. By the middle of 2009 the [[Recession of 2009/Addendum#World trade|world trade statistics]] were  also showing signs of a recovery, and  growth  continued through the second half of 2009 and into the first quarter of 2010, although the volume of trade remained substantially below pre-recession levels<ref>
==Slowdown 2011-2013==
[http://www.oecd.org/dataoecd/52/38/45684950.pdf ''OECD International Trade Statistics, News release, 21 July 2010'']]</ref>.
Growth continued in the early months of 2011 and [[/Addendum#The United States|United States growth]] accelerated in the second half, but elsewhere there was a general slowdown, and  by the end of the year,  recession is believed to have returned to the European economy. The  slowdown is thought to be attributable to a range of factors, including:<br>
&nbsp;&nbsp;&nbsp;(a) the completion of the stockbuilding phase of the [[inventory cycle]] that normally follows a [[recession (economics)|recession]];<br>
&nbsp;&nbsp;&nbsp;(b) the [[Shock (economics)|economic shock]] caused by the [[tsunami|Japanese tsunami]] of March 2011;<br>
&nbsp;&nbsp;&nbsp;(c) the loss of output due to the continuing [[deleveraging]] by banks and the consequent restriction of credit to companies;<br>
&nbsp;&nbsp;&nbsp;(d) the effect on demand of continuing deleveraging by companies and households;<br>
&nbsp;&nbsp;&nbsp;(e) the effect on demand of the reductions in [[public expenditure]] and the other [[fiscal adjustment]]s;<br>
&nbsp;&nbsp;&nbsp;(f) the reduction in the availability of [[credit (finance)|credit]] resulting from precautionary action by European banks in anticipation of the [[restructuring of debt|restructuring]] of the Greek government's debt;<br>
&nbsp;&nbsp;&nbsp;(g) losses of investor and consumer confidence prompted by the fear of a global financial crisis triggered by a major [[sovereign default]] in the eurozone.<br>


By the end of 2009, most economies had returned to economic growth, but the recession continued into 2010 in the [[/Addendum#The Baltic States|Baltic States]], [[/Addendum#Ireland|Ireland]], [[/Addendum#Greece|Greece]] and [[/Addendum#Spain|Spain]]. Vigorous eofconomic growth returned to the emerging economies in the Far East, but  growth of the mature economies remained well below trend through 2010 and into 2011, leaving substantial [[output gap]]s unclosed. By the middle of 2010,  the world economy was experiencing vigorous growth, with the  growth rates of many developing economies having returned to pre-recession levels. However the world economy had suffered an [[shock (economics)|economic shock]] in the form of an exceptionally damaging earthquake and tsunami, and a political shock with expected economic consequences in the form of major [[Arab Spring|Arab uprisings]].  A general loss of confidence (which it attributed to those events and to the  US debt limit dispute  and to the developing [[eurozone crisis]]) prompted the Economist Intelligence Unit in August 2011 to assign a 40 per cent probability to the occurence of  a [[double-dip recession|"double dip"]]  within the following two years.<ref>[http://viewswire.eiu.com/index.asp?layout=VWArticleVW3&article_id=1508374735&region_id=1510000351&refm=vwReg&page_title=Latest+regional+analysis&fs=true&mkt_tok=3RkMMJWWfF9wsRonvqrIZKXonjHpfsXx6%2BUtULHr08Yy0EZ5VunJEUWy2YUDRdQhcOuuEwcWGog8xQVNSA%3D%3D&rf=0 ''World economy: Darkening outlook'', Economist Intelligence Unit, August 17th 2011]</ref>. Of more immediate concern was the sharp increase in the 3-month [[LIBOR-OIS spread]] which started at the beginning of August. Although much smaller than that of 2008, it signalled an increase in the [[liquidity risk]] faced by the banks and the possibility that they might react by  creating a [[credit crunch]].
==The policy debate==
 
<!--
==Fiscal aftermath (2010 - 12 )==
The size of the [[fiscal multiplier]] has a decisive bearing on whether the output costs of a chosen rate of [[fiscal consolidation]] are outweighed by the investor confidence benefits of its consequent debt reduction. The assessment that they are is the implicit basis of the fiscal policy of most European countries. The possibility that that assessment may have been based upon underestimates of the multiplier has raised doubts about the merits of current policy choices<ref>[http://www.voxeu.org/article/self-defeating-austerity Dawn Holland and Jonathan Portes, ''Self-defeating austerity?'', Vox, 1 November 2012]</ref>. It has even led some analysts to suggest that over-rapid fiscal consolidation may be self-defeating - causing increased borrowing as a result of reduced tax revenues and increased social security costs<ref>[http://ec.europa.eu/economy_finance/publications/economic_paper/2012/pdf/ecp460_en.pdf Jocelyn Boussard, Francisco de Castro and Matteo Salto: ''Fiscal Multipliers and Public Debt Dynamics in Consolidations'', European Commission, July 2012]</ref>..
As the recovery got under way, policy-makers were faced by the [[fiscal policy/Tutorials#The fiscal dilemma|fiscal dilemma]], that arose from the conflict been the wish to reduce their recession-inflated [[national debt]]s and the wish to avoid creating another [[downturn  (economic)|downturn]]. In October 2009, the International Monetary Fund had advised that, notwithstanding rising public debt in many countries, fiscal stimulus needed  to be sustained until the recovery is on a firmer footing and may even need to be extended, but that it could lose its effectiveness in the absence of convincing reassurances to investors  that government  debt will eventually be rolled back<ref>[http://www.imf.org/external/pubs/ft/weo/2009/02/pdf/text.pdf. ''Sustaining the Recovery'', World Economic Outlook, International Monetary Fund, October 2009]</ref>. During the early months of 2010, national authorities in most of the developed countries became concerned  that operators in the bond markets might demand the addition of substantial  [[risk premium]]s to the normal rates of return on new issues of government bonds. In the event, the yields on the government [[bond (finance)| bonds]] of the developed countries fell to record lows<ref>[http://citywire.co.uk/money/government-bond-yields-sink-to-record-lows-on-double-dip-fears/a425848 James Phillipps: ''Government bond yields sink to record lows on double dip fears'', Citywire, 25 August 2010]</ref> (except those of the [[PIIGS]] countries<ref>[https://news.fxpro.com/news/view_news/4528 ''PIGS bonds under huge strain again'', FXpro 26 August 2010]</ref>), substantially improving the [[fiscal sustainability|sustainability]] of their [[public debt|debt]]. In Europe, a consensus nevertheless developed in favour of allowing the [[fiscal stimulus|fiscal stimuluses]] of 2009 to lapse, and to adopt plans for the rapid reduction of [[budget deficit]]s; and [[G20]] leaders resolved to halve their deficits by 2013<ref>[http://www.g20.org/Documents/g20_declaration_en.pdf. G20 Summit Declaration, July 27 2010]</ref>.  A different view was taken by the United States government. Treasury Secretary Geithner argued that an immediate deficit reduction would inhibit economic recovery<ref>[http://www.bbc.co.uk/news/business-12307906 ''Davos 2011: Geithner resists pressure for drastic cuts'', BBC News January 28 2011]</ref>, and a budget programme was  adopted that would increase the country's budget deficit to its highest proportion of GDP in its history<ref>[http://www.cbo.gov/ftpdocs/120xx/doc12039/SummaryforWeb.pdf ''The Budget and Economic Outlook: Fiscal Years 2011 to 2021'', Congressional Budget Office, January 2011]</ref>.
 
During 2010, prospective investors became increasingly reluctant to buy the  [[bond]]s isued by five [[PIIGS]] (Portugal, Ireland, Italy, Greece and Spain) governments at the offered interest rates,  and the governments concerned had to make a succession of increases in those rates when they needed to [[roll-over]] existing debt.  Two of those governments - Greece and Ireland - eventually decided that, without help,  they  would not be able to continue to  finance their budget deficits,  and they sought - and received - loans from other European governments. Those loans failed to reassure potential investors, and a [[eurozone crisis]] developed. In November  investors  demanded further increases in the interest rates on  the  government bonds of all five governments (including  those of Portugal, Spain and Italy,  because of fears of [[contagion (banking)|contagion]] from Greece and Ireland). By December 2010, there was widespread uncertainty about future prospects for the eurozone. There were doubts about the willingness of European governments to provide further financial support to the five "PIIGS" governments, and speculation that financing difficulties might spread to affect other governments.


==The cost of the recession==
Estimates of the size of the output gap can be subject to a significant degree of uncertainty<ref>[http://budgetresponsibility.independent.gov.uk/wordpress/docs/briefing%20paper%20No2%20FINAL.pdf Estimating the output gap. UK Office of Budget Responsibility, April 2011]</ref><ref>[http://ftalphaville.ft.com/2012/10/04/1191411/why-the-uk-output-gap-could-be-a-chasm/ Izabella Kaminska, ''Why the UK output gap could be a chasm'', FT Alphaville, Oct 4 2012]</ref> -->
The problem of estimating the cost of the recession is immensely difficult, requiring a comparison between its actual outcome and the outcome that would have eventuated in its absence. Even to estimate its actual output presents difficulties that may not be confidently resolved for many years. An attempt has nevertheless been considered necessary  in order to provide a datum against which to relate  the costs of prevention. An estimate by Bank of England has put the [[present value]] of the cost of the output that has been lost at 3½ times world GDP, on the basis of which their Andrew Haldane has suggested that if only 25 percent of that loss were permanent, the present value of its global cost could amount to 90 per cent of the value of a year's output
<ref name=haldane>[http://www.bankofengland.co.uk/publications/speeches/2010/speech433.pdf Andrew Haldane: ''The $100 billion Question'', Comments given at the Institute of Regulation & Risk, Hong Kong, 30 March 2010, Bank of England April 2010]</ref>.


==Diagnoses and prescriptions==
==Diagnoses and prescriptions==
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===Prescriptions===
===Prescriptions===
In a reversal of the previous consensus, there was general agreement by 2009 that further [[financial regulation|regulation of the financial  industry]] is necessary.  It was also accepted that the new regulations should not be concerned solely with the stability of individual firms.
In a reversal of the previous consensus, there was general agreement by 2009 that further [[financial regulation|regulation of the financial  industry]] is necessary.  It was also accepted that the new regulations should not be concerned solely with the stability of individual firms.
A paper by the United States Department of the Treasury makes the point that "a narrow micro-prudential concern for the solvency of individual firms, while necessary, is by itself insufficient to guard against financial instability. In fact, actions taken to preserve one or a few individual banking firms may destabilize the rest of the financial system"<ref  name=treasury>[http://www.treas.gov/press/releases/docs/capital-statement_090309.pdf ''Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms'', US Treasury Department, September 2009]"</ref>.  The term "macroprudential" came into general use to denote concern with the integrity of the financial system as a a whole. There was also seen to be need for international agreement, if only in order to avoid a situation in which financial firms migrate  toward the least-regulated administration.  
A paper by the United States Department of the Treasury makes the point that "a narrow micro-prudential concern for the solvency of individual firms, while necessary, is by itself insufficient to guard against financial instability. In fact, actions taken to preserve one or a few individual banking firms may destabilize the rest of the financial system"<ref  name=treasury>[http://www.treas.gov/press/releases/docs/capital-statement_090309.pdf ''Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms'', US Treasury Department, September 2009]"</ref>.  The term "macroprudential" came into general use to denote concern with the integrity of the financial system as a whole. There was also seen to be need for international agreement, if only in order to avoid a situation in which financial firms migrate  toward the least-regulated administration.  


The Deputy General Manager of the Bank for International Settlements has set out a broad agenda for the reform of the international economy<ref>[http://www.bis.org/speeches/sp100303.pdf Hervé Hannoun; ''Toward a Global Financial Stability Framework'', Speech to the 45th SEACEN Governors’ Conference Siem Reap province, Cambodia, 26–27 February 2010, Bank for International Settlements]</ref>
The Deputy General Manager of the Bank for International Settlements has set out a broad agenda for the reform of the international economy<ref>[http://www.bis.org/speeches/sp100303.pdf Hervé Hannoun; ''Toward a Global Financial Stability Framework'', Speech to the 45th SEACEN Governors’ Conference Siem Reap province, Cambodia, 26–27 February 2010, Bank for International Settlements]</ref>
Line 139: Line 150:
Work was already in hand to develop the first of those proposals. In December 2009, the [[Basel Committee on Banking Supervision]] had issued consultative proposals, introducing a [[leverage ratio (banking)|leverage ratio]] requirement, a [[liquidity]] requirement,  and a range of [[countercyclical]] measures<ref>[http://www.bis.org/publ/bcbs164.pdf ''Strengthening the resilience of the banking sector'', (A Consultative Document) Basel Committee on Banking Supervision, December 2009]]</ref> that came to be known as "Basel III", and a range of [[Financial regulation/Addendum#Legislation|national legislation]] had already been enacted.
Work was already in hand to develop the first of those proposals. In December 2009, the [[Basel Committee on Banking Supervision]] had issued consultative proposals, introducing a [[leverage ratio (banking)|leverage ratio]] requirement, a [[liquidity]] requirement,  and a range of [[countercyclical]] measures<ref>[http://www.bis.org/publ/bcbs164.pdf ''Strengthening the resilience of the banking sector'', (A Consultative Document) Basel Committee on Banking Supervision, December 2009]]</ref> that came to be known as "Basel III", and a range of [[Financial regulation/Addendum#Legislation|national legislation]] had already been enacted.
There had been discussions about banking regulation at [[G20 summit|Heads of State meetings]] and [[G20 Finance Ministers meetings|Finance Ministers meetings]] of the [[Group of Twenty]] leading economies. International agreement on specifics was elusive, however, and the situation at April 2010 was summed up by the Governors of the [[International Monetary Fund]] as  
There had been discussions about banking regulation at [[G20 summit|Heads of State meetings]] and [[G20 Finance Ministers meetings|Finance Ministers meetings]] of the [[Group of Twenty]] leading economies. International agreement on specifics was elusive, however, and the situation at April 2010 was summed up by the Governors of the [[International Monetary Fund]] as  
"Strengthening financial regulation, supervision, and resilience remains a critical but as yet incomplete task."<ref>[http://www.imf.org/external/np/sec/pr/2010/pr10166.htm ''Communiqué of the Twenty-First Meeting of the International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund'', 24 April 2010]</ref>, and Andrew Haldane of the Bank of England commented  that "although several packages of remedial measures have been enacted,  the "great debate" on the future structure of finance has only just begun"<ref name=haldane/>.
"Strengthening financial regulation, supervision, and resilience remains a critical but as yet incomplete task."<ref>[http://www.imf.org/external/np/sec/pr/2010/pr10166.htm ''Communiqué of the Twenty-First Meeting of the International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund'', 24 April 2010]</ref>, and Andrew Haldane of the Bank of England commented  that "although several packages of remedial measures have been enacted,  the "great debate" on the future structure of finance has only just begun"
 
International agreement of the second BIS proposal - that monetary policy should "lean against" asset price booms - seems unlikely because it has been opposed by the Chairman of the Federal Reserve Board<ref>[http://www.federalreserve.gov/BoardDocs/Speeches/2002/20021015/default.htm Ben Bernanke: ''Asset-Price "Bubbles" and Monetary Policy'' (Speech to the New York Chapter of the National Association for Business Economics, New York, New York, October 15 2002) Federal  Reserve Board 2002]</ref> and the President of the European Central Bank<ref>[http://www.ecb.int/press/key/date/2005/html/sp050608.en.html Jean-Claude Trichet: ''Asset price bubbles and monetary policy'',(Mas lecture, 8 June 2005) European Central Bank, 2005]</ref>.  
International agreement of the second BIS proposal - that monetary policy should "lean against" asset price booms - seems unlikely because it has been opposed by the Chairman of the Federal Reserve Board<ref>[http://www.federalreserve.gov/BoardDocs/Speeches/2002/20021015/default.htm Ben Bernanke: ''Asset-Price "Bubbles" and Monetary Policy'' (Speech to the New York Chapter of the National Association for Business Economics, New York, New York, October 15 2002) Federal  Reserve Board 2002]</ref> and the President of the European Central Bank<ref>[http://www.ecb.int/press/key/date/2005/html/sp050608.en.html Jean-Claude Trichet: ''Asset price bubbles and monetary policy'',(Mas lecture, 8 June 2005) European Central Bank, 2005]</ref>.  


Line 150: Line 160:
Occasional slowdowns are natural and necessary features of a market economy.  
Occasional slowdowns are natural and necessary features of a market economy.  
<ref>[http://www.iea.org.uk/record.jsp?type=pressArticle&ID=376 ''Keynesian over-spending won't rescue the economy'', Letter by IEA economists in the Sunday Telegraph, 26 October 2008]</ref>
<ref>[http://www.iea.org.uk/record.jsp?type=pressArticle&ID=376 ''Keynesian over-spending won't rescue the economy'', Letter by IEA economists in the Sunday Telegraph, 26 October 2008]</ref>
-->
-->


==References==
==Notes and references==
{{reflist|2}}
{{reflist|2}}[[Category:Suggestion Bot Tag]]

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In addition to the text below, this article consists of an annotated chronology of the main events of the recession; and accounts of the regional impact of the recession.
It was last updated on 26 February 2013.

The Great Recession[1] occurred against a background of financial deregulation and financial innovation, and of capital flows from developing to developed economies. Its precursors were sharp increases in global food and oil prices, a housing market breakdown in the United States, and a related global banking panic.

Its categorisation as "great" was prompted by the fact that it was the first recession to involve a reduction in the recorded economic activity of the world as a whole. Every major economy was affected. The developed economies experienced contractions, and the developing economies experienced reductions in their growth rates. In many of the developed economies it also developed the (almost) unprecedented character of a balance sheet recession, in which banks use deposits to rebuild reserves, rather than to give credit, and households use income to pay off debt rather than to make purchases.

The trough of the Great Recession occurred mostly in 2009. A global recovery was under way in 2010, but it was hampered by the deleveraging effects of balance sheet crises, and by economic shocks including the Japanese tsunami of March 2011, and by contagion from the eurozone crisis. In most developed economies, the operation of their economies' automatic stabilisers had the effect of driving the public debt to unprecedented peace-time levels, prompting the introduction of austerity programmes designed to restore investor confidence in the sustainability of their fiscal policies. A substantial amount of unused capacity persisted through 2012 and into 2013.

Introduction

This article is the fourth of a series of contemporary accounts of financial and economic events and developments during the period from mid 2007 to the end of 2011. The other articles are:-

Subprime mortgage crisis - events surrounding the bursting of a house price bubble in the United States in mid 2007;
Crash of 2008 - global financial developments from mid 2007 to the end of 2008;
Recession of 2009 - global economic developments from mid 2007 to the end of 2010

Overview

During the 1980s there was a widespread re-appraisal of the regulations that had been introduced in response to the financial instability that developed during the Great Depression. It was concluded that the financial regulations of the 1930s had become unnecessary because recently-developed monetary policy could be used to counter any further signs of instability. Ongoing programmes of banking deregulation that had prevented investment banks from engaging in branch banking, insurance or mortgage lending were dropped, and reserve requirements were relaxed or removed.

After the mid-1980s came 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.

In the United States, that period was characterised by massive capital inflows, and the large-scale availability of credit to households. By 2007, their personal savings rates had dropped to 2 per cent of disposable income from their previous average of 9 per cent and there was a house price boom that has since been categorised as a bubble. The bursting of that bubble in 2007, and the downgrading by the credit rating agencies of large numbers of internationally-held financial assets created what came to be known as the subprime mortgage crisis, which led, in turn, to a global financial crisis involving the failure of several of the world's largest banks. In September 2008, the loss of investors' confidence caused by failure of the Lehman Brothers investment bank resulted in the curtailing of financial activity on a scale that amounted almost to the collapse of the global financial system. Its total collapse was averted towards the end of 2008 by systemic rescue measures that included the general recapitalisation of the banks and guarantees of unlimited financial support. The global banking system remained in a fragile condition, however, as a result of its discovery of the need to writedown the value of its assets because of their inclusion of substantial amounts of toxic debt. The effect of that discovery was their realisation of the need for deleveraging (in order to limit their leverage risks), and of the consequent need to limit their lending. The result was a reduction in the supply of credit to households and businesses that became known as a credit crunch.

The effect of the credit crunch, on top of an earlier surge in oil and commdity prices, was a reduction in consumption and investment. Despite the launching of numerous national programmes of fiscal and monetary expansion, the result was a fall in global economic activity in which the world's developing economies experienced reductions in their growth, and its developed economies experienced periods of negative growth.

By the end of 2009, growth had resumed in most of the world's economies, but pre-crisis growth rates were not restored except among emerging and developing economies. Growth among the developed economies was generally held back by the lasting damage that had been done to their financial sectors, and by the expenditure effects of reductions in household debt. Consequently there was continued underutilisation of productive capacity and unemployment continued to rise. Many governments had been forced to borrow money by issuing bonds, to offset the fiscal consequences of their automatic stabilisers, as a result of which there had been major increases in national debt.

The recovery continued throughout 2010, but by its third quarter, the effects of fiscal stimuluses had peaked in most of the developed economies. Despite the persistence of unused capacity, European governments were generally reluctant to provide further fiscal support for fear of adverse market reactions to the bond issues that would be required. In response to that fear, European governments reduced their public expenditure plans and increased taxation. The Government of the --------United States, on the other hand, continued its policy of fiscal and monetary expansion. The indebtedness of the governments of Greece and Ireland rose to unsustainable levels, and a eurozone crisis began to develop as conditional eurozone "bailout" loans failed to reassure investors in their bonds.

During the first half of 2011, the world economy as a whole experienced vigorous growth , but the growth of the developed economies remained slow and hesitant. In the course of 2011 the confidence of investors and households was damaged by a series of shocks, and by the continuing failure of the authorities to resolve an expanding eurozone crisis. There was a decline in the growth rates of most European economies. and signs of contagion from the eurozone crisis to economies outside Europe.

Background: the great moderation (1985 - 2007)

Domestic stability

The central problem of depression-prevention [has] been solved, for all practical purposes.

Robert E. Lucas,
Presidential Address to the American Economic Association, January 10, 2003[2].

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[3]. It was not clear at the time whether the "Great Stability", as it came to be called[4], should be attributed 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 [5], referred to by others in America as the "Greenspan effect" [6], 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"[7], under which monetary policy was targetted on the output gap using an empirical relationship such as the Taylor rule.

A general expectation of continued growth persisted until the recession struck: for example the International Monetary Fund's World Economic Outlook of April 2007 forecast that "world growth will continue to be strong"[8].

International volatility

There was a contrasting increase in the volatility of the international financial system - which experienced 139 financial crises during the 24 years from 1973 to 1997, compared with 38 during the previous 26 years [9]. Many of those crises were associated with the development of globalisation and its accompanying large and volatile international capital flows. At first the predominant direction of flow was from the developing countries to the developing countries, but that changed toward the end of the 20th century with the development of very large global imbalances . The oil-exporting countries as well as Japan, China, and some other east Asian emerging developing nations accumulated large current account surpluses, and correspondingly large current account deficits developed elsewhere, especially in the United States, the United Kingdom, Ireland and Spain. Flows of capital into the advanced countries rose from about 8 per cent of world GDP in 2002 to about 16 per cent in 2007 [10]. Nearly all of the corresponding investments of the surplus countries were in the government bonds or government-guaranteed bonds of the deficit countries and the increased demand for those bonds enabled their issuers to reduce their yields - typically from a real (ie inflation-adjusted) yield of 3 per cent in 1990 to less than 2 per cent in the early 21st century[11].

Housing booms

The increased availability of credit at low interest rates prompted large household debt increases in the United States and Europe, much of which was used to finance expenditure on housing. In response to the increase in demand there were almost unprecedented increases in house prices in several countries. In the United States real (inflation-corrected) prices rose by nearly 85 percent between 1997 and 2006[12], in the United Kingdom there was an (uncorrected) rise of 180 per cent [13], in Spain they nearly trebled[14], and in Ireland they more than quadrupled [15]. By 2005, some economists in the United States had become convinced that an asset price bubble had developed[16], but Ben Bernanke (then Chairman of the President's Council of Economic Advisers) reported that "... although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals" and that "a moderate cooling in the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year"[17]. In the event, price increases grew more rapidly over the following year and a half[18].

Deregulation

American attitudes about regulation changed substantially during the final three decades of the 20th century. Beginning in the 1970s, policy-makers grew increasingly concerned that economic regulation protected inefficient companies at the expense of consumers [19]. Deregulation of the banks began in the 1980s and involved a combination of changes in federal and state statutes and changes in regulatory and judicial interpretations of existing laws, culminating in the passage of the Banking Act of 1999, and there were similar developments in other developed countries[20]. Until the 1980s, investment banks were not normally permitted to undertake non-financial activities, nor other financial activities such as branch banking, insurance or mortgage lending. In the 1980s, however, there was extensive deregulation of the banks with the intention of increasing competition and improving efficiency. Reserve requirements were relaxed and restrictions upon the range of their financial activities were generally relaxed or removed[21].

Financial innovation

The reduction that took place in the yields on government bonds prompted investors to seek higher-yielding alternatives, and the finance industry employed a great deal of high-powered ingenuity to meet that demand. They were helped in that endeavour, firstly by a series of Nobel-prize-winning advances in financial economics that had been made in the 1970s and early 1980s; secondly by the deregulations of the 1980s, and thirdly by the work of a group of brilliant mathematicians that came to be known as the "quants"[22]. The economists had developed a succession of theories based upon adaptations of the efficient market hypothesis, including portfolio theory and the capital asset pricing model; on the basis of which the quants developed and operated a range of computer packages that could provide precise estimates of an investor's "value at risk" derived from probability analysis of previous experience. Armed with more sophisticated methods of assessing risk, the banks and other financial intermediaries increased their capacity to provide credit to producers and consumers by distributing the risks and rewards involved more widely among those most willing to accept them. The devices adopted for that purpose included a vastly extended application of the techniques of securitisation, involving the conversion of their loans into packages of bonds that were graded according to the credit risk ratings provided by the credit rating agencies. The traditional banking practice of holding loans on their balance sheets until they were repaid, gave way to the strategy known as originate and distribute, under which those packages of bonds were sold to pension funds, insurance companies and other banks. That procedure removed the loans from the balance sheets of the banks, and the institutions of the growing shadow banking system, thus enabling them to increase activity without breaching the reserve ratio requirements of the financial regulators.

Financial crisis (2007 - 2008)

In recent decades, a vast risk management and pricing system has evolved combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel prize was awarded for the discovery of the pricing model that underpins much of the advance in the derivatives markets. This modern risk management paradigm held sway for decades.

The whole intellectual edifice, however, collapsed in the summer of last year.

(Testimony of Dr. Alan Greenspan before the Committee of Government Oversight and Reform October 23, 2008[4])

What came to be known as the subprime mortgage crisis had its origin in repayment defaults by some Americans with low credit ratings who had borrowed money to help pay for house purchases. When house prices were rising, many of them had been able to get the money needed for repayments by further borrowing (because of the increased collateral that the price increases enabled them to offer). But the sharp fall in the market value of their houses that occurred in 2007 deprived them of that option, and left many of them owing more than their houses were worth - making default a rational, and sometimes unavoidable, recourse.

The financial crisis began in early June 2007, when surge in defaults led the credit rating agencies to downgrade their ratings of securities based upon those mortgages, and banks holding such securities found themselves unable to use them as collateral for their borrowing needs. This created financial problems that started with the government-sponsored mortgage lenders Fannie Mae and Freddie Mac and then shifted to the major banks [23]. In that month, hedge funds guaranteed by the American Bear Stearns bank ran into difficulties, and mortgage defaults led subsequently to the collapse - and a government rescue from bankruptcy of Fannie Mae and Freddie Mac. Uncertainty about the quality of banking assets made banks reluctant to lend to each other and the important interbank market virtually ceased to operate, triggering a credit shortage.

The events of 9th August 2007 marked the first upsurge in the intensity of the crisis. The French bank BNP Paribas announced that it had suspended withdrawals from three of its hedge funds on the grounds that it had become impossible to value their mortgage-backed assets. On the same day it became apparent that European banks were experiencing serious liquidity shortages when it was learned that they had sought help from the European Central Bank. Other banks throughout the world cut back on their lending in an attempt to offset the increase in their leverage brought about by the downgrading of their mortgage-based assets. The fear of default fed on itself as a result of more and more major bank failures in 2007 and 2008 as well as many failures of other businesses - often because they found themselves unable to roll-over their debts. In March 2008 the United States authorities organised the rescue of the Bear Stearns (the world's fifth largest investment bank)].

The second upsurge of financial panic started in September 2008. The collapse of the Lehman Brothers investment bank[24] [25] on September 15 created a near total loss of mutual confidence throughout the world's financial system. The LIBOR-OIS spread [26] which is the conventional measure of the banks' willingness to lend, which had already risen to 0.9 per cent from its normal level of around 0.1 per cent, surged to an unprecedented 3.6 per cent. Fears of default spread through the financial system with the crippling consequences that came to be known as the credit crunch. Banks and other businesses found that they could not borrow for longer than overnight, and by early October even overnight credit became scarce. It become apparent that a collapse of the entire financial system had become a distinct possibility, and the Governor of the Bank of England warned that "Not since the beginning of the First World War has our banking system been so close to collapse"[27].

The International Monetary Fund's economists estimated in October 2009 that the global writedowns of the value of financial assets resulting from the crisis to have totalled $3.4 trillion. [28]

Policy response (2008 - 2009)

Financial policy

In the course of the first two weeks of October 2008 a series of banking systems rescue plans had been launched[29]. The UK had announced large scale plans to inject capital into its banks and to offer unlimited guarantees on the debts of all of its banks, and similar action had shortly after been agreed by European leaders and by the President of the United States. The national rescue systems that were actually adopted by the principal banking countries differed only in detail from those initial proposals. It was recognised that those actions were temporary treatments, not remedies, and remedial measures were also set in motion in the course of 2009, as described in the paragraph below on diagnosis and remedies.

Monetary policy

The Federal Reserve Bank, the Bank of Japan and the Bank of England made a series of discount rate reductions to near zero levels in the 4th quarter of 2008 and the 1st quarter of 2009 (and the European Central Bank made a series of reductions to reach 1 per cent in the 2nd quarter. When it became clear that those moves had not achieved the intended easing of the credit crunch it was decided to adopt the controversial and largely untried policy of quantitative easing.

Fiscal policy

In a significant departure from the accepted practice of relying solely upon monetary policy to stabilise their economies, most industrialised countries adopted fiscal stimulus packages to augment the already substantial expansionary influence of the automatic stabilisers. Those moves frequently involved departures from recently adopted deficit-limiting rules, including The European Union's Stability and Growth Pact, and the United Kingdom's Code for Fiscal Stability and levels of national debt ranging from the UK's 44 per cent of GDP to Japan's 188 per cent were forecast to rise to at least double their existing proportions of GDP .

Economic downturn (2007 - 2009)

(the country links in the following paragraphs are to the regional notes on the addendum subpage)
... the first annual decline in world output in more than half a century.

(Economic Report of the President, 2010)

The economic downturn started in the United States in the first quarter of 2007, where a combination of rising oil prices, falling house prices and credit shortages was having a depressing effect on household spending and business investment. The downturn continued during the next three quarters, and its depressing effects were being felt by the economies of many of the other advanced economies[30]. The financial problems created by the subprime mortgage crisis had a further depressing effect, and the financial panic that followed the demise of the Lehman Brothers investment bank in September 2008 created further - and much more serious - obstacles to economic activity and to trade. By the fourth quarter of 2008 recessionary pressures were being felt in all of the world's economies[31]. There were massive reductions in world trade during that quarter and in the first quarter of 2009. Also during the first quarter of 2009, the oil price fell sharply to reach 25 per cent of its 2008 peak, and there were substantial downturns in the housing markets of several advanced economies (including Canada, Denmark, Ireland, Spain and the United Kingdom), and - for the first time since the Great Depression, there were simultaneous reductions in the growth of nearly all of the world's economies.

Regional impacts varied widely, however. There was little change to the economies of Southern Asia; those of East Asia were less adversely affected than most; the economies of China and India experienced significant growth rate reductions; and all the high-income economies of the United States, Europe and Japan, together with most of the other developing countries, went into recession. The severest effects were upon the economies of Russia, the Baltic States, Iceland and Ireland. There were widespread increases in unemployment.

The recession had struck widely for reasons that often had nothing in common with the events that set it off. Economies with relatively large financial sectors - such as those of Britain and Iceland - suffered directly from the banking crisis. Economies with relatively large export sectors - such as those of Japan and Germany and many developing countries - suffered indirectly from the collapse in world trade that occurred at the end of 2008[32]. Commodity-exporting countries in Africa and Central and South America were affected by the fall in commodity prices, the fall in the oil price hit the oil- exporting countries such as Russia and Mexico, and the international credit crunch created financial problems for developing countries who found themselves unable to roll-over maturing short-term debt. In several countries, (including the United States, the United Kingdom and Ireland ) the recession had the historically rare characteristics of a balance sheet recession[33], which they suffered as a result of the acquisition of toxic debt from the American subprime mortgage crisis. In the United States, Japan and the United Kingdom, the effect of deleveraging by the banks was accentuated by attempts by businesses and households to reduce their inflated levels of debt.

Fiscal aftermath (2009-13 )

As the recovery got under way, policy-makers were faced by the fiscal dilemma, that arose from the conflict been the wish to reduce their recession-inflated public debt and the wish to avoid creating another downturn. In October 2009, the International Monetary Fund had advised that, notwithstanding rising public debt in many countries, fiscal stimuluses needed to be sustained until the recovery is on a firmer footing and may even need to be extended, but that it could lose its effectiveness in the absence of convincing reassurances to investors that government debt will eventually be rolled back[34]. During the early months of 2010, national authorities in most of the developed countries became concerned that operators in the bond markets might demand the addition of substantial risk premiums to the normal rates of return on new issues of government bonds. In the event, the yields on the government bonds of the developed countries fell to record lows[35] (except those of the PIIGS countries[36]), substantially improving the sustainability of their debt. In Europe, a consensus nevertheless developed in favour of allowing the fiscal stimuluses of 2009 to lapse, and to adopt plans for the rapid reduction of budget deficits; and G20 leaders resolved to halve their deficits by 2013[37]. A different view was taken by the United States government. Treasury Secretary Geithner argued that an immediate deficit reduction would inhibit economic recovery[38], and a budget programme was adopted that would increase the country's budget deficit to its highest proportion of GDP in its history[39]. During 2010, a eurozone crisis developed as investors became increasingly reluctant to buy the bonds isued by the governments of Greece, Ireland and Portugal, and the governments concerned had to make a succession of interest rate increases in order to roll-over maturing debt. The governments concerned eventually decided that, without help, they would not be able to continue to finance their budget deficits, and they sought - and received - loans from other European governments. Those measures failed to reassure the bond market, and there were continuing increases in their yield spreads over German bonds.

Economic Recovery (2009-2011)

Early in 2009 there were signs of a gradual return of confidence in operation of the financial system. There was no longer a prospect of the collapse of the financial system, but nor was there an immediate prospect of a return to normal. Bank executives were by then acutely aware of the need to reduce leverage and were devoting available funds to that purpose rather than to lending. As a result there was no more than a gradual reduction in the severity of the credit crunch [40]. There were also signs of a return to the growth of economic activity. World output rose at 3¼ per cent per annum in the second quarter of 2009, and at 4½ per cent in the second half as a whole. Most of the growth occurred in the emerging economies. In the developed economies, the pace of recovery was slow, and activity remained far below precrisis levels. Growth was led by a rebound in manufacturing and the rebuilding of depleted inventories[41]. By the middle of 2009 the world trade statistics were also showing signs of a recovery, and growth continued through the second half of 2009 and into the first quarter of 2010, although the volume of trade remained substantially below pre-recession levels[42].

By the beginning of 2010, most economies had returned to economic growth, but the recession continued into 2010 in the Baltic States, Ireland, Greece and Spain. Vigorous economic growth returned to the emerging economies in the Far East, but growth of the mature economies remained well below trend through 2010, leaving substantial output gaps unclosed. Nevertheless the world economy as a whole experienced over 5 per cent growth in 2010, with the growth rates of many developing economies having returned to pre-recession levels[43].

Slowdown 2011-2013

Growth continued in the early months of 2011 and United States growth accelerated in the second half, but elsewhere there was a general slowdown, and by the end of the year, recession is believed to have returned to the European economy. The slowdown is thought to be attributable to a range of factors, including:
   (a) the completion of the stockbuilding phase of the inventory cycle that normally follows a recession;
   (b) the economic shock caused by the Japanese tsunami of March 2011;
   (c) the loss of output due to the continuing deleveraging by banks and the consequent restriction of credit to companies;
   (d) the effect on demand of continuing deleveraging by companies and households;
   (e) the effect on demand of the reductions in public expenditure and the other fiscal adjustments;
   (f) the reduction in the availability of credit resulting from precautionary action by European banks in anticipation of the restructuring of the Greek government's debt;
   (g) losses of investor and consumer confidence prompted by the fear of a global financial crisis triggered by a major sovereign default in the eurozone.

The policy debate

Diagnoses and prescriptions

Causes

Even before the banking meltdown had been averted, attention was being given to the problem of identifying its causes with a view to avoiding another financial crisis (or, failing that, of limiting its severity). Many explanations were put forward. Some were concerned with the conduct of those involved, including the shortcomings of bank executives and their advisors, the laxity of their regulators, the indifference of the central banks, the incompetence of the credit rating agencies, and the inaction of governments. Some were concerned with institutional factors including, the inadequacy of financial regulation, and the lack of coordination between monetary policy and financial regulation. The concern felt by many people that a global disaster had been sprung on them without warning was expressed by the Queen of England when, on a royal visit to the London School of Economics, she asked "Why did no-one see it coming". The School's Director assured her that economists had issued warnings[44], and a follow-up letter attributed their lack of influence among decision-takers to "wishful thinking combined with hubris" [45]. {The warnings included those of Paul Volcker[46], and William White [47].). But a group of eminent economists believe that the economics profession cannot escape responsibility for the crisis. Positions of influence had in their view been occupied by economists who had a mistaken view of how the economy works. Among that group, George Akerlov and Joseph Stiglitz argue that a major cause of the crash of 2008 had been the use of models embodying the efficient markets hypothesis and, more generally, to the belief that financial markets are inherently stable[48]. The economist Paul Krugman claims that those responsible for economic management had acted either on the belief that free-market economies never go astray, or the belief that deviations could readily be corrected by the central banks, and that economists' preoccupation with elegant mathematical models had led them to "mistake beauty for truth"[49]. A contrary view is taken by Nobel prizewinner Myron Scholes (joint creator of theBlack-Scholes model which embodies the efficient markets hypothesis), who defends the use of models and attributes any adverse consequences to their misuse, saying "you can build a wonderful car such as a Porsche or a Lamborghini and turn it over to someone to drive it who has no skills and causes it to crash"[50].

Prescriptions

In a reversal of the previous consensus, there was general agreement by 2009 that further regulation of the financial industry is necessary. It was also accepted that the new regulations should not be concerned solely with the stability of individual firms. A paper by the United States Department of the Treasury makes the point that "a narrow micro-prudential concern for the solvency of individual firms, while necessary, is by itself insufficient to guard against financial instability. In fact, actions taken to preserve one or a few individual banking firms may destabilize the rest of the financial system"[51]. The term "macroprudential" came into general use to denote concern with the integrity of the financial system as a whole. There was also seen to be need for international agreement, if only in order to avoid a situation in which financial firms migrate toward the least-regulated administration.

The Deputy General Manager of the Bank for International Settlements has set out a broad agenda for the reform of the international economy[52] that included:

Work was already in hand to develop the first of those proposals. In December 2009, the Basel Committee on Banking Supervision had issued consultative proposals, introducing a leverage ratio requirement, a liquidity requirement, and a range of countercyclical measures[53] that came to be known as "Basel III", and a range of national legislation had already been enacted. There had been discussions about banking regulation at Heads of State meetings and Finance Ministers meetings of the Group of Twenty leading economies. International agreement on specifics was elusive, however, and the situation at April 2010 was summed up by the Governors of the International Monetary Fund as "Strengthening financial regulation, supervision, and resilience remains a critical but as yet incomplete task."[54], and Andrew Haldane of the Bank of England commented that "although several packages of remedial measures have been enacted, the "great debate" on the future structure of finance has only just begun" International agreement of the second BIS proposal - that monetary policy should "lean against" asset price booms - seems unlikely because it has been opposed by the Chairman of the Federal Reserve Board[55] and the President of the European Central Bank[56].

In the communiqué issued after the 2009 Pittsburgh summit the world leaders reiterated the need to manage global imbalances [57], - a topic that had been regularly discussed at summits over the previous decade - but did not propose any means of doing so. There seems little chance of G20 agreement on Heribert Dieter's proposal to levy a penalty on surplus countries [58], nor on the alternative of penalising deficit countries. An alternative, proposed by Charles Goodhart and Dimitrios Tsomocos, would be taxes on capital flows[59].


Notes and references

  1. The term Great Recession was used in the 2010 report to the President of the United States by his Council of Economic Advisers[1], and has since become colloquial].
  2. Robert E. Lucas, Jr: Presidential Address to the American Economic Association, January 10, 2003
  3. Olivier Blanchard and John Simon; "The Long and Large Decline in US Output Volatility, Working Paper 01-29,Brookings Institute April 2001
  4. James H. Stock and Mark W. Watson: Has the Business Cycle Changed and Why?, NBER Working Paper No. W9127, National Bureau of Economic Research, 2002
  5. Ben Bernanke: The Great Moderation", lecture to Eastern Economic Association, February 20, 2004
  6. David B. Sicilia and Jeffrey L. Cruikshank: The Greenspan Effect, Words That Move the World's Markets, McGraw-Hill, 2000
  7. Charles Bean Is There a Consensus in Monetary Policy?
  8. IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004-07, IMF Independent Evaluation Office, February 2011
  9. Martin Wolf Fixing Global Finance, page 35, Yale University Press, 2009
  10. Olivier Blanchard and Gian Maria Milesi-Ferretti: Global Imbalances: In Midstream?, Fig 4, IMF Staff Position Note, International Monetary Fund, December 2009
  11. The Turner Review. A regulatory response to the global banking crisis, Financial Standards Agency, March 2009
  12. The Subprime Lending Crisis, US Senate Joint Economic Committee, October 2007
  13. BBC news 2006 Friday, 27 October 2006]
  14. Spain Property Prices 1995 - 2007, Ministerio de Vivienda, 2008
  15. Daniel Kanda: Asset Booms and Structural Fiscal Positions: The Case of Ireland, International Monetary Fund, March 2010
  16. Yale Professor Predicts Housing 'Bubble' Will Burst, Robert Shiller interview with Madeleine Brand June 23 2005
  17. Ben Bernanke: The Economic Outlook, Testimony to the Joint Economic Committee October 20 2005
  18. Robert J. Shiller: Historic Turning Points in Real Estate, Cowles Foundation Discussion Paper No. 1610, Figure 1, June 2007
  19. [http://usa.usembassy.de/etexts/oecon/chap2.htm How the U.S. Economy Works, United States Embassy{
  20. Claudio Borio and Renato Filoso: The changing borders of banking: trends and implications, Bank for International Settlements, December 1994
  21. James Barth and Gerard Caprio: Rethinking Bank Regulation: Till Angels Govern, Cambridge University Press 2008.
  22. Scott Patterson: The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, Random House 2010
  23. Financial Stability Report, pages 18 & 19, Bank of England October 28 2008
  24. Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner’s Report, 2010,
  25. Public Policy Issues Raised by the Report of the Lehman Bankruptcy Examiner, Hearing by the United States House of Representatives Financial Services Committee, April 20, 2010
  26. Rajdeep Sengupta and Yu Man Tam: The LIBOR-OIS Spread as a Summary Indicator, Federal Reserve Bank of St Louis, 2008
  27. Speech by Mervyn King, Governor of the Bank of England, 21 October 2008
  28. Global Financial Stability Report, International Monetary Fund. October 2009
  29. "A chronology of policy responses to the financial market crisis", Appendix A.1A, OECD Economic Outlook, December 2008
  30. World Economic Outlook, International Monetary Fund, October 2008
  31. World Economic Outlook, April 2008, International Monetary Fund
  32. Cheung, C. and S. Guichard: Understanding the World Trade Collapse, OECD Economics Department Working Papers, No. 729, OECD Publishing, October 2009
  33. Richard C. Koo: U.S. Economy in Balance Sheet Recession: What the U.S. Can Learn from Japan’s Experience in 1990–2005, Testimony to the House of Representatives Financial Services Committee, 10th February 2010
  34. Sustaining the Recovery, World Economic Outlook, International Monetary Fund, October 2009
  35. James Phillipps: Government bond yields sink to record lows on double dip fears, Citywire, 25 August 2010
  36. PIGS bonds under huge strain again, FXpro 26 August 2010
  37. G20 Summit Declaration, July 27 2010
  38. Davos 2011: Geithner resists pressure for drastic cuts, BBC News January 28 2011
  39. The Budget and Economic Outlook: Fiscal Years 2011 to 2021, Congressional Budget Office, January 2011
  40. Financial Stability Report, Bank of England, June 2009
  41. World Economic Outlook, International Monetary Fund October 2009
  42. OECD International Trade Statistics, News release, 21 July 2010]
  43. World Economic Outlook Projections, International Monetary Fund, September 2011, Table 1.1.
  44. Luis Garicano: I did not stammer when the Queen asked me about the meltdown, The Guardian, Tuesday 18 November 2008
  45. Letter to the Queen from the British Academy, 22 July 2009
  46. Paul Volcker: An Economy On Thin Ice, Washington Post, April 10, 2005
  47. William R White: Procyclicality in the financial system: do we need a new macrofinancial stabilisation framework?", Bank for International Settlements, January 2006
  48. The Economic Crisis and the Crisis in Economics, INET Inaugural Conference @ King’s College April 8-11, 2010 Institute for New Economic Thinking[2]
  49. Paul Krugman: How Did Economists Get It So Wrong?, New York Times, 2 September 2009
  50. Interview with Stephanie Flanders, 2 November 2009
  51. Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms, US Treasury Department, September 2009"
  52. Hervé Hannoun; Toward a Global Financial Stability Framework, Speech to the 45th SEACEN Governors’ Conference Siem Reap province, Cambodia, 26–27 February 2010, Bank for International Settlements
  53. Strengthening the resilience of the banking sector, (A Consultative Document) Basel Committee on Banking Supervision, December 2009]
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