Keywords

Great Recession • Housing market bubble • Financial innovation • Overconfidence • Pricing of risk • Banking regulation • Public debt overhang • Euro crisis • Global imbalances • Supply chain and bullwhip effect • Trade collapse • Capital restrictions

Introduction

In the previous chapter we defined a financial crisis as a situation where the financial system no longer functions properly to the extent that the negative consequences are felt in the real or non-financial sector of the economy as well. We also developed an analytical framework to better understand the causes and consequences of financial crises. In Chapter 12 we will use our insights on financial crises and on the pros and cons of international capital mobility more generally to analyse what is arguably already the largest financial crisis in the post-Second World War period, the so-called Great Recession that was still very much with us at the time of writing this book. To many people this crisis started with the collapse of Lehman Brothers on 15 September 2008. But as one can see from Table 12.1, the rumblings of the (near) financial meltdown of the global economy in the autumn of 2008 date back at least to 2007 when the US housing and mortgage market got into trouble. As the time line in Table 12.1 illustrates, what started out as a problem on the US housing market turned into a global banking crisis in 2008 which in turn led to a government debt crisis and, in particular in the euro countries, into a (single) currency crisis. The reason to call this, still unfolding, financial crisis the Great Recession is that this crisis had and in many countries still has a strong negative impact on the real economy, with global income and trade nose-diving in 2009 to the effect that we faced a global recession. Unlike the 1930s, when the world economy was hit by a financial crisis that became known as the Great Depression with a prolonged contraction of the real economy, the negative impact of the current crisis has (so far) been more limited, hence the term Great Recession instead of Great Depression.