Research Running head MONETARY

Unlock access to all the studying documents.

View Full Document

Running head: MONETARY POLICY ANALYSIS

THE GREAT RECESSION

Ani Barseghyan

Bus 603

March 11, 2018

Monetary Policy 2

Introduction

The great recession refers to the period (2007-2013) marked by general decline in

economic activities across major markets across the globe. The recession was the worst

experience since the 1930’s. The primary causes of the recession originated from the United

States of America and spread out to the rest of the world. However, the impact of the recession

was not felt evenly across the globe. Notably, the developed economies felt a greater impact than

the developing economies. The great recession met the basic criteria for gaining the global status

of a recession within a short period of less than a year. The years before the beginning of the

recession were characterized by an exorbitant rise in the price of most assets leading to a boom

in economic activities. Improper practices in the banking sector contributed significantly to the

collapse of the economy. The mortgage-backed by securities had significant risks that were hard

to assess. The impact of the improper economical practices was spread and soon flowed to the

rest of the world.

Historical Context

The great recession began in late December 2006 to early 2013. The factors leading to the

great recession were internal. The market conditions in the real estate industry preceded the great

recession.

Causes of the Economic Recession

The Housing Bubble

The period before 2006 witnessed a rise in the price of typical American houses. The

price increase in some of the cases was more than 100%. The situation resulted in a section of

the homeowners paying for their homes at low interest rates. Alternatively, a section of the

Monetary Policy 3

homeowners opted to finance their spending by applying for other mortgages that would be

secured by increase in price (Bartels, 2014). There was high speculation that the price of the

houses would continuously appreciate.

The increase in price levels was above the average inflation rates in the economy. There

was a significantly high increase in the household debt, lower savings rate and a decline in the

homeownership rates. The housing bubble was predominant in the coastal regions where

building new homes was restricted by geographical factors and the recommended land use by the

government (Del Negro, & Schorfheide, 2015). The housing bubble resulted in more

homeowners refinancing their mortgages. The consumers were keen on taking second

mortgages that would be secured by the rising prices for the houses.

However, by September 2008, the prices had declined by about 20% from their peak

prices in 2006. Most of the homeowners rushed to obtain adjustable rate mortgages. The enticed

the borrowers with interest rates that were below the prevailing market rates. The consumers

were to comply with the adjusted rate for a given duration of time (Bell, & Blanchflower, 2011).

In the instance where the borrowers did not make a huge payment during the grace period, they

were allowed to refinance their mortgages. Refinancing the mortgages would soon become

difficult as the prices of the houses in the market was facing a steady decline.

As the housing prices increased, there was a sharp decline in the consumer saving. The

consumers were also spending a lot and borrowing a lot. There was s significant growth in the

household debt. Speculations have it that in early 20068, an Average consumer has more than ten

credit cards. The credit and house price explosion led to a building boom which resulted in the

housing prices reaching the peak (Bell, & Blanchflower, 2011). There was a significant

Monetary Policy 4

increase in the homeownership rates in the United States of America. However, most of the new

owners could not service their mortgages and opted to refinance their mortgages.

Mortgage Crisis

The housing bubble resulted in the subprime mortgage crisis. The decline in residential

investment resulted in the global recession and later on, there was a reduction in household

spending and business investments in the economy. Speculative borrowing among the

homeowners contributed significantly to the mortgage crisis. The housing prices had doubled,

and the homeowner was speculative of the further increases in the price of the houses. The

market behavior has a significant impact on the lenders. They offered more loans without

adhering to the lending standards. Some of the lenders offered their products at interest rates