By 2008 the US trade deficit was still very large (roughly 5% of gross income) and our net debt position was around $5 trillion (over 1/3 of gross income). Unfortunately, it also appears that we have fallen into a major recession of uncertain duration and depth. Discuss the causes of this current recession, and: a) the discernible differences between Keynesian and Classical (aka Monetarist) in their preferred approach to recovery; and b) the parallels with Japan's (non-) recovery.
The causes of the 2008 recession are complex and multifaceted, but some key factors include the housing market crisis, financial system vulnerabilities, and the global interconnectedness of economies. Here's how you can delve into these causes:
1. Housing market crisis: To understand the housing market crisis, you can research the subprime mortgage lending practices, which refers to the granting of mortgages to borrowers with weak credit history. Look into the excessive risk-taking by financial institutions, securitization of mortgages, and the subsequent burst of the housing bubble. Investigate the impact of these factors on home prices, foreclosures, and the broader economy.
2. Financial system vulnerabilities: The interplay between financial institutions and the housing market crisis exacerbated the recession. Look into the role of banks, investment firms, and rating agencies. Research the increase in leverage and the expansion of complex financial instruments like mortgage-backed securities and collateralized debt obligations. Understand how the failure of Lehman Brothers and the subsequent banking crisis contributed to the downturn.
3. Global interconnectedness: Investigate how the recession spread globally due to the interconnectedness of economies. Research the impact of the crisis on trade, capital flows, and global financial markets. Explore the contagion effect and the challenges faced by countries in managing the impact of the recession on their own economies.
Now, let's discuss the differences between the Keynesian and Classical (Monetarist) approaches to recovery:
a) Keynesian approach: Keynesian economics emphasizes government intervention to stimulate demand during a recession. Keynesians believe that during economic downturns, increased government spending on infrastructure projects, tax cuts, and expansionary monetary policy can boost economic growth. They argue for active management of the economy through fiscal and monetary policies to reduce unemployment and stimulate consumer spending.
b) Classical (Monetarist) approach: Monetarists, influenced by economists like Milton Friedman, emphasize the importance of controlling the money supply and maintaining low inflation. They believe that limited government intervention is necessary, and that the focus should be on maintaining price stability and allowing the free market to correct itself. Monetarists argue against excessive government spending and emphasize the importance of sound monetary policy to stabilize the economy.
Now, let's draw parallels with Japan's (non-) recovery:
Japan faced a prolonged recession and economic stagnation during the 1990s, often referred to as the "Lost Decade." Some parallels between Japan's situation and the 2008 recession include:
1. Bursting of asset bubbles: Both Japan and the U.S. experienced the collapse of asset bubbles (real estate and stock market bubbles) that had fueled economic growth. The aftermath of these bursts led to a sustained period of economic weakness.
2. Financial system vulnerabilities: Similar to the U.S., Japan faced challenges with its financial system. In Japan's case, it was due to excessive lending and speculative investments by banks and corporations during the 1980s. When these investments went bad, it strained the banking sector and hindered economic recovery.
3. Policy response: Japan's policymakers initially relied on monetary policy measures and fiscal stimulus to try to revive the economy. However, their response was slower and less aggressive compared to some of the actions taken by the U.S. government during the 2008 recession. This delayed and inadequate response is often attributed to Japan's slow recovery.
By examining these parallels, you can gain a deeper understanding of the causes of the 2008 recession and the different approaches to recovery.