Abstract
The current paper explores the main differences of the Great Recession in 2007-2009 from other economic collapses in the history if the United States. Section I discusses the general features of a recession and describes the main responsibilities of the National Bureau of Economic Research. Section II is devoted to the comparison of the Great Recession with the recession of 1980s. The section is divided into four subsections. Subsection A presents the basic comparison of recessions in the U.S. history and explains the choice of the 1980s period for the further comparison. Subsection B explores differences in unemployment in 1980s and in the Great Recession and reveals the reason of the Great Recession to have a more severe effect on the labour market. Subsection C discovers the impact of two recessions on the financial sector and provides the correlation between the interest rate change and FDI asset growth. Subsection D surveys the public debt rise in both recessions and the difference in the pace of growth. Section III provides some policy recommendations to protect the economy against new recessions and it consists of two main parts – subsection A is devoted to the labour market recommendations and subsection B proposes some fiscal and monetary measures. The summary of the paper is introduced in the conclusion.
The main features of the Great Recession (2007-2009) that did not exist before
Section I. The recession, according to the National Bureau of Economic Research. The responsibility for deciding whether the economy of the United States in an economic recession or not belongs to the National Bureau of Economic Research (NBER) that was founded in 1920 as a private non-profit research organization. More specifically, all the decisions concerning the dates of peaks and troughs of recessions as well as the maintaining of the chronology of the United States business cycles are determined by the Business Cycle Dating Committee.
According to the NBER, the term recession is defined as a period of continuous significant decline in economic activity that can last from a few months to more than a year between a peak and a trough in economic development. The Business Cycle Dating Committee identifies a month when the economy reached a highest peak of activity settling a beginning of a recession. The month when the economy reached a trough is the end of recession. The recession is not a period when the economy is diminished, but a period when the economic activity is diminishing. The period between a trough and a peak is expansion. The Committee also specifies that during a recession, there could happen short periods of expansion as well as a short-term contraction can be followed by further growth within a long-term period of expansion.
The Great Recession began, according to NBER, at the end of 2007 and considered to be the worst recession in the U.S.’s history since the Great Depression. When industrial production declined by 37%, prices by 33%, and real GNP by 30%, Unemployment rose to a peak of 25% and remained above 15 % during the rest of 1930-s (P.Temin 1).
Though the Great recession had the same features as other recessions in the U.S. history, it is considered to be completely different from other U.S. collapses as well as those in other developed countries. Lee E. Ohanian in the paper “The Economic Crisis from a Neoclassical Perspective” describes the last 2007-2009 recession as more severe if to analyze the behavior of the key variables like output, consumption, investment, and labor. The Professor highlights that a large decline in labor input in the U.S. was the main reason of the lower output and income, while in other U.S. recessions it was the productivity decline that caused decreasing output. He also argues that labor market deviations could have been caused by a number of abstract shocks – monetary shocks, fiscal policy shocks, terms-of-trade shocks or taste shocks (L. Ohanian 48).
Robert E. Hall along with slackness in the labor market and in total factor productivity presents also such biggest contributor to the U.S. recession as a shortfall in business capital that was not observed before in other U.S. recessions (R. Hall 3).
Section II. Sharp recessions in the U.S. history. The GDP behavior after the Great Depression and the second world war helps to identify the most ailing recessions in the US history for further data comparison with the Great Recession in 2007-2009. After the Second World War the most significant decline in the GDP growth (that is the first feature of the recession) the USA saw in 1958, 1980s, and later in 2008. The 1980s recession saw the sharpest fall in the GDP by over 8% that is comparable to the current Great Recession, that’s why this period will be used for the analysis.
Subsection A. Basic comparison of recessions. The early 80-s recessions include very short period of 6-month decline in 1980 that appeared to be a response to the raised interest rate against the inflation of the 1970s. Then the economy had a very quick relaxing period of growth followed by the second deepest and long lasting recession in 1982 as a result of the Iranian revolution, sharply increased oil price and followed further energy crises.
Galloping inflation continued forcing the Federal Reserve to increase interest rates, heating more unemployment, despite the fact, that GDP, productivity and personal income remained nearly at the same level. In 1982 the unemployment rate reached 10,8% and in some regions it exceeded 16% (Michigan, Alabama, West Virginia), according to the NBER statistics. The recession had also a damaging impact on financial institutions.
The Great Recession 2007-09 started with a mortgage crisis that was characterized by an extreme rise in asset prices and a boom in economic demand that resulted in the housing bubble and further lead to the global financial crisis spread for other economies. The Great Recession was characterized by a deep fell in international trade, growing unemployment and a sudden drop in commodity prices. The GDP growth was decreasing steadily and reached negative -8,2 % in 2008, the unemployment rose by 5,8 % in 2008 and had continued its growth till 2010 (9,6 %). Since then, the unemployment never returned to the pre-crisis level. The last recession experienced the highest fell in the industrial production in comparison to other previous collapses - the industrial production index sharply dropped by 11 %.
Source: National Bureau of Economic Research; Economic report of the President (1959); Federal reserve bank of St. Louis, Gross domestic Product, Unemployment, CPI index. Web. 03 Mar 2016
The Table 1 summarizes the main indicators, characterizing three recessionary periods in the United States and proves that the Great Recession in 2007-2009 was significantly severe and had a more damaging impact on the U.S. economy than all other previous recessions. An economic slump lasted eighteen months, followed by the record decline in the GDP growth by -8.2 per cent. The Industrial production index saw the highest fall by 11.3 per cent that was twice as much as during any other recession in the U.S. history. The inflation pace was lower than during previous crises and reached its negative figure in 2009, that never happened before.
Subsection B. Differences in unemployment in 1980s and the Great Recession. As it was mentioned in the research of Lee E. Ohanian and Robert E. Hall, one of the main differences and most influencing contributor of the recession was the highest rate of the unemployment. However, the data shows, that in early 80-s the average unemployment rate was even higher than in 2007-2009 (see table 1).
Source: Federal reserve bank of St. Louis, Unemployment. Web. 03 Mar 2016
If to compare the unemployment in both crises (see fig.1), it is possible to notice that the unemployment rate in 2007-2009 recession had more violent character while in 1980s it rose slowly. Besides, after the end of 1980s recession the unemployment started calming down. The Great Recession was long-term. Though the NBER declared the end of the recession in June 2009, the U.S. had been suffering its consequences until the end of 2012 with the high unemployment, low consumer prices, rising federal debt, inflation rate and prices. The main reason why the U.S. suffered more severe unemployment in 2007 than before was the housing market crash that was followed by rapidly rising housing prices and a bubble effect that had a direct impact on banks, mortgage markets, real estate and personal savings.
Subsection C. The impact of two recessions on the financial sector. One of the specific features of the Great Recession could be the high impact on the financial sector, specifically, the decline in the capital contribution due to the collapse of investment. Previous crisis took place in more closed and framed economy. The crisis period in early 1980 saw also a rapidly rising asset at an average level of 30% despite a short slowdown in 1983. However, the 2007 saw an extremely rapid decreasing in asset and a negative -2.9% level in 2009. The steadily growing foreign investment activity appeared after 1970s with the interest rate increased by the Federal Reserve. Figure 3 demonstrates the reaction of foreign direct assets in response to the interest rate changes.
The important difference that is notable in the picture 3 is a direct correlation between the interest rate increase and the rise in foreign direct investments in the 1980s recession period (see fig.2). This feature continues until the 2000s crises when the correlation suddenly got inversed after the dot-com crisis. The same peculiarity is witnessed in the Great Recession: while the interest rate is declining the FDI was growing. The housing market crash had a severe impact on the financial sector and defined the investment changes in the U.S. economy. The zero lower nominal interest rate has exacerbated the Great Recession as it restricted the ability of monetary policy to resist demand shocks (Hall 431).
Source: Federal reserve bank of St. Louis, FDI asset, Effective Federal Funds Rate. Web. 03 Mar 2016
The rise in investment despite the low interest rate was explained by Matthew Rognlie, Andrei Shleife and Alp Simsek. According to their model, the recession can be divided into two phases and the rise in FDI is typical for the second phase when nonresidential investment rises and drives the recovery, while residential investment still remains low (Rognlie, Shleife and Simsek 4).
Subsection D. The public debt in recession. The pace and the size of government debt also helps to compare two recessions in terms of governments’ ability to serve the debt. The share of public debt in GDP has risen by 28% during the Great Recession, that was completely different from the experience the U.S. had before. Though the pace of growth was nearly the same as during the early 80s recession. Meanwhile, the public debt continued growing steadily after the end of the recession but with less speed (see fig.3).
Source: Federal reserve bank of St. Louis. Federal Debt: Total Public Debt, Debt to GDP. Web. 03 Mar 2016
The reason of rapid debt growth can be connected to the difference in interest rates. This difference in 1980s and in 2009 (10 percent visa 4,5 percent averagely) creates different scenarios for the public debt, because the government has to serve the debt and make interest payments regularly. The credit bubble appeared in 2007 contributed a lot to the damaging effect of the Great recession and became one of the reasons the current recession to be more severe than the one in 1980s. In addition, interest payments in 2010 were at historic lows of 5,7% when the average ratio of interest payments between 1960 and 2010 was at about 10 per cent (Pollin 169).
Section III. Policy recommendations to avoid a new recession. The U.S. still suffer from the recession that ended a while ago, and the best way to insure the economy against mew possible recession is to model a monetary, fiscal and tax policy regarding support of the unemployed.
Subsection A. Labor policy recommendations. As it was seen in the analysis the crisis feeds the unemployment so that it becomes the most crucial consequence. The unemployment depends on the economic growth. The main priority of the economic policy should be a direction to the aggregate demand and economic growth. In order to prevent the recession, caused by the shortfall in the labor market the government should accumulate enough reserves and to be able to provide welfares and financial aid to the organizations that usually start to discharge the staff. Given the example of the Action Plan for Jobs and National Talents Drive Program established in Ireland, that is focused on providing subsidy and funding to employers. The program was targeted to employ more than 2 million people (specifically, youth) and had a tremendous success (National Reform Programme, 2015, p. 15-23). The American government could use this example to recover and secure the labor market from further recessions.
Subsection B. Fiscal and monetary policy recommendations. In terms of monetary policy, the government should avoid rising interest rates in order to provide credit opportunities for households and residential investment, however, at the same time it important to avoid the credit excess that previously stimulated the housing market crash. Besides, the government taxation policy should control financial institutions and prevent too rapid banks’ expansion because of the systematic domino effect. A progressive tax should grow with the size of assets holding back the extremely rising banks to damage the economy. As we can see from the U.S. experience the uncontrolled freedom created banks too big to fail that became the first symptom and reason of the coming recession.
Another recommendation is careful attention to the rising public debt as a new recession could be due to the large debt-to-GDP share. However, the 2000s dot-com experience proved that the high pace of rising debt is more likely to cause instability than a great debt-to-GDP share (The Economist). Thus, it is recommended to keep close attention to the pace of debt and to increase interest payments at least 10 per cent of GDP, thus the government could be able to serve the debt.
Besides, it is very important to provide an effective monetary policy that could be a protection against currency instability. Less less debt share in foreign currency and massive foreign exchange reserves are to prevent dependency on the currency volatility as the market became very fluctuant. The present financial system is more vulnerable due to the high volatility in the exchange rates. Moreover, Foreign currency debt is widely believed to increase risks of financial crisis (M.Bordo, C.Meissner, and D. Stuckler 3).
Conclusion. The analysis showed that the financial crises and the housing market crash both appeared to play a significant role to make the Great Recession (2007-2009) in the United States the fiercest economic tragedy in the U.S. history after the Great Depression in 30-s and the Second World War. The continuing, damaging, and spreading impact on the U.S. economy and other world economies was completely different from all previous crises. The GDP decline reached the record rate followed by the highest fall in the industrial production index, deep unemployment and inflation, along with capital escaping and rising public debt.
The slump in 1980s has been chosen for comparison with the Great Recession because the GDP decline was nearly the same that the current recession suffered. Besides, the 1980s crisis had also the very damaging impact on the unemployment at about 10% and the inflation rate was close to ten per cent that is also close to the Great Recession indicators.
The analysis of economic indicators of two recessions showed that the Great Recession saw more long-term and deep unemployment lasting until the end of 2012 despite the end od the recession. Then, the impact on the financial sector was also different. While the interest rates were growing in the 1980s recession along with the foreign assets rise the Great recession experienced low interest rates. However, the foreign assets continued to grow. The main reason for differences in unemployment and the financial sector is the impact of housing market crash in 2007 that has no place before in 1980s. The bubble caused deep unemployment and had a direct impact on households, mortgage markets, real estate, personal savings and residential investment. Low interest rates also affected the significant rise of public debt in 2007-2009 because they reduce the relative cost of interest payments on government debt. As a result, in 2010 the U.S. saw the lowest 5,7% level of interest payments.
According to the analysis some recommendations to avoid the new recession have been provided. First of all, it is vitally important for the government to accumulate enough reserves for providing welfares and financial aid to the organizations to keep the employment at a low level. In terms of fiscal policy, it was proposed the government should impose progressive taxation on growing financial institutes to avoid the expansion of too big banks to fail. Regarding the monetary policy, it is necessary to keep interest rates above 1-2 per cent thus providing better opportunities to borrowers and maintaining the public debt rate that is rising sharply with interest rates close to zero.
The global economy is a very complex, unpredictable and volatile creature to make simple forecasts. Future business cycles are more dependent on other actors’ behavior. Liberalization in Europe can affect the dollar and the Federal Reserve’s decisions concerning rising interest rate. It is hardly possible to create a reliable economic policy so that it could protect the country against the consequences of other global actors. Before there had not existed so tight dependency on the international trade and the recession in the US remained mostly within the U.S. economy, however, the high growth of the world trade led to the global interdependency with the U.S. at the hub and prone to crisis. In case of recession, globalization can result now in a domino effect and global recession in other economies.
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