Great Recession

Overview

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

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

The consensus view among economists was that the combination of monetary and fiscal expansion that was then undertaken by policy-makers was necessary to avoid a global catastrophe 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. There followed sharp reductions in the levels of activity in most of the world's developed economies, mainly because the discovery that they had been overestimating the value of their assets was prompting damaging reactions by banks and households. The banks at first restricted their lending because of doubts about the reliability of the collateral offered by prospective borrowers and later, when those doubts receded, to avoid losing the confidence of their depositors by holding an excessive amount of debt as a proportion of their own capital. The practice of debt reduction (known as deleveraging) was also adopted by those households that acquired historically high levels of indebtedness, many of whom were experiencing unaccustomed falls in the market value of their houses.