Last Updated 22 Jun 2020

Global financial crisis

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The 2008-2009 global financial crisis started from the American Housing. It rapidly spread to other economic sectors and shortly infected Europe and Japan, and also influenced other countries with respect to their dependence on America’s economy. How did the global financial crisis start?

Banks and financial foundations invested in housing for gaining more profit. Housing Banks in lending to customers to greedy more profits did not observe criteria relating to customers financial ability and their repay power. Later, banks for covering loan risks, increased interest rates, borrowers who were not able to pay loans, decided to sell their houses. According to high interest rate, they did not find customer. So home prices start to fall and the bubble burst. By bursting the bubble, borrowers did not pay their loans and banks faced to empty houses. Thus banks failed one after another and crisis spread to other parts of America economy and Recession started

Similarity between2001 and 2008-2009 global financial crisis One similarity is that consumption has actually decreased in both recessions. As the fall in bank capital reduces; consumption, investment and housing have decreased the real wealth of households. Thus, people feel poorer and spend less. The sharp decrease in consumer spending and business confidence that resulted from the financial crisis, reflected by falls in real personal consumption of 3.8% (3rd Qtr 2008) and 4.3% (4th Qtr 2008) for the United States economy, led to significant shift to the left of The IS curve in an IS-LM model. The result in the short-run was a substantial decrease in output, output would have declined to Y1 as shown below.

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Another similarity is the consequences. The U.S. recession of 2001 caused 1) 2.1 million people lost their jobs, as unemployment rose from 3.9% to 5.8%. 2) GDP growth slowed to 0.8%, (compared to 3 9% average annual growth during (compared to 3.9% average annual growth during 1994-2000).

On the other hand, the global economic downturn has resulted in an employment crisis: Global unemployment increased by 8.4 million in 2008 (7.4 percent) and global job losses could hit 50 million in 2009. The last similarity is regarding the government policy, fiscal and monetary policy was both conducted to tackle the recessions. In 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) released mainly aimed for tax deduction. Moreover, government spending was increased as shown below:

Also, monetary policy was released to shorten recessions by encouraging. The monetary expansion policy including:

1) Purchase of government bonds by central banks through Open Market Operations(OMO)

2) Reducing banks' reserve requirements (CRR ; SLR)

3) Increased borrowing stimulates business expansion

4) Reducing the cost of borrowing

While in the year 2008, federal decreased the federal fund rate from 5.25% to 0% and Congress spent $700 billion to rescue financial system for addressing the impact of global financial crisis. Both fiscal and monetary policy shifted IS curve to the right and moved LM curve downwards.

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