Hello everybody, I am Ninh Nguyen. My seminar topic today is late 2000s recession. My presentation aims to review economics in short run via a real life case study.
Recession is a phase of busyness cycle. We will come back to the definition of economic fluctuation.
Economic Fluctuationwhich is usually known as “Business Cycle” (or “EconomicCycle"), refers to economy-wide fluctuations in production or economic activity overseveral months or years.Business cycles are composed of two phases and two turning points.Two phases:- Expansion (or Recovery or Boom): Time in which real GDP rises and unemployment declines.- Contraction (or Recession): Time in which real GDP declines and unemployment rises.Two Turning points:-Peak: Real GDP reaches its maximum, stops rising, and begins to decline.- Trough: Real GDP reaches its minimum, stops declining, and begins to rise.s
There are three key facts of economic fluctuation.
The first key fact is Economic Fluctuations are irregular and unpredictable.Despite being termedcycles, most of these fluctuations in economic activity do not follow a mechanical orpredictable periodic pattern. They are almost impossible to predict with much accuracy. As you can see in this graph, shaded areas indicate US recession through out history. Sometimes recessions are close together such as 50s – 60s, sometimes the economy goes many years withouta recession such as 60s – 70s or 90s – the first years of 2000s. The late 2000s recession is one of the worst one in history.
And what are effects of recession? Here is a map of global recession status, most countries still in recession with red color and just a few green countries expanding such as, China, India, Indonesia, Quatar,…
The unit using tomeasure economic fluctuation isthe growth rate of real gross domesticproduct (GDP).In this recession, real GDP began contracting in the third quarter of 2008, and by early 2009 was falling at an annualized pace not seen since the 1950s.
This graph shows you more clearly about export growth of some economies. All negative.
The International Labor Organization (ILO) predicted that at least 20 million jobs will have been lost by the end of 2009 due to the crisis — mostly in "construction, real estate, financial services, and the auto sector" — bringing world unemployment above 200 million for the first time. The number of unemployed people worldwide could increase by more than 50 million in 2009 as the global recession intensifies, the ILO has forecast.Look at the graph we can see G7 labor conditions worsening quickly.
So what are the origins of this recession? Come back to the theories. We already known that there are two causes of economic fluctuations. They are the effects of shifts in aggregate demand and aggregate supply. But in this case study, what cause these shifts?
The Dot com bubble burst in 2001. Shares in internet companies collapsed and with events of 9/11, the US faced recession. The Federal Reserve responded by cutting interest rates to 1% - there lowest level for a long time. this gives even more places for banks to borrow from, creating easy Credit, Easy credit was fueled by the US, and foreign capital growth.The Easy Credit allows more people to buy houses causing a Housing Boom, the increase of demand raises the prices of houses.Almost everyone who wanted a house, now has one due to the easy credit. Wall Street became wealthy with all the cheap credit, and decided they wanted more. Investment Bankers, bought mortgages from Mortgage Lenders, and turned them into CDO’s, which investors could invest in. Investment Bankers, who having huge success with the CDO’s, want more.The demand for CDO’s remains high.The Mortgage Lender, has no mortgages to sell to Investment bankers, so they lower the loan standards. At this point, there are now less requirements to get a loan, giving less responsible people, a chance to get a loan, why do they not care? They make money off of the selling of the mortgage, and it no longer is there problem, but the investment bankers problem.Housing prices, which had been practically rising forever, began to fall. The incomes of the families throughout this time had remained the same as housing prices had been rising, making houses, unaffordable, even with the easy loans. As houses were still being built, the market had to correct itself to the natural laws of supply and demand, and this resulted in the fall of housing prices.The financial market had not planned for housing prices to drop, and were completely dependent on the thought that they could not, in fact, a “safe” investment in a CDO was considered safe because it was backed by houses of good increasing value. The fall of housing prices completely overturned the system. Subprime crisis.Panic, virtually stopped lending. Some, afraid they would not get their money back, others could not afford it, after losing so much capital. Credit crisis.The lack of credit caused the mad selling of stocks, bankruptcies, cutoffs, increased unemployment, lower spending, and less production.The global economy shrinks, and there is less money to go around.
This chart is based on the chart of Jeffrey A. Frankel, professor from Harvard Kennedy School.
When facing recession, how policymaker responded? If policy makers do not respond, such shifts in aggregate demand cause short-run fluctuations in output and employment. As a result, policy maker use monetary policy and fiscal policy to try to offset these shifts in aggregatedemand and thereby stabilize the economy.
In January 2009, the Obama administration announced a stimulus plan to revive the economy with the intention to create or save more than 3.6 million jobs in two years. The cost of this initial recovery plan was estimated at 825 billion dollars (5.8% of GDP). The plan included 365.5 billion dollars to be spent on major policy and reform of the health system, 275 billion (through tax rebates) to be redistributed to households and firms, notably those investing in renewable energy, 94 billion to be dedicated to social assistance for the unemployed and families, 87 billion of direct assistance to states to help them finance health expenditures of Medicaid, and finally 13 billion spent to improve access to digital technologies. The administration also attributed of 13.4 billion dollars aid to automobile manufacturers General Motors and Chrysler, but this plan is not included in the stimulus plan.
So what conclusion can we come to?
There are many causes have been named:….
But there are 3 systemic reasons for the crisis!
They are incentives, risk management and complexity.Misaligned incentives were pervasive from home buyer, investor to executives as you already saw when I explain how the financial crisis happened.Companies didn’t manage risk correctly, they seems to ignore the worst case and no concern about rare risk.Financial market is too complex, and it will never be simple with component interact in unexpected way. If there is a problem, it no opportunity to intervene, just like an airplane flying, you can’t stop in the mid-air to fix the engine. Complexity also makes a small problem can cause a reaction that can destroy the whole system and poison surrounding area.
All we agree that recession is so bad but I still have an optimistic view. It has some advantages such as you have more time for family, to update yourself, to meet other people, you can travel and buy with cheap price,…