The 2008-2009 recession was long and deep, and according to several factors was the most
severe economic contraction since the 1930s (but still much less severe than the Great
Depression). The slowdown of economic activity was moderate through the first half of 2008, but
at that point the weakening economy was overtaken by a major financial crisis that would
exacerbate the economic weakness and accelerate the decline.
I believe the crisis was the product of few factors. Only when taken together can they offer a sufficient explanation of what happened:
Starting in the late 1990s, there was a broad credit bubble in the U.S. and Europe and a sustained housing bubble in the U.S. . Excess ...view middle of the document...
A rapid succession of 10 firm failures, mergers and restructurings in September 2008 caused a financial shock and panic. Confidence and trust in the financial system dissolved, as the health of almost every large and midsize financial institution in the U.S. was questioned. The financial shock and panic caused a severe contraction in the real economy as another factor.
Those individuals across the financial sector pursued their self-interest first, sometimes to the disadvantage of borrowers, investors, taxpayers and even their own firms. I also agree that the mountain of government programs supporting the housing market produced distorted investment incentives, and that the government's implicit support was a ticking time bomb.
But it is dangerous to conclude that the crisis would have been avoided if only U.S Government had regulated everything a lot more, had fewer housing subsidies, and had more responsible bankers. Simple narratives like these ignore the global nature of this crisis, and promote a simplistic explanation of a complex problem. Though tempting politically, they will ultimately lead to mistaken policies.
Measures taken by U.S Government
Both monetary and fiscal policies as well as some extraordinary measures were applied to counter
the economic decline. This policy response is thought to have forestalled a more severe economic
contraction, helping to turn the economy into the incipient economic recovery by mid-2009.
These policies likely continued to stimulate economic activity into 2012.
Monetary Policy Actions
To bolster the liquidity of the financial system and stimulate the economy, during 2008 and 2009
the Federal Reserve (Fed) aggressively applied conventional monetary stimulus by lowering the
federal funds rate to near zero and boldly expanding its “lender of last resort” role, creating new
lending programs to better channel needed liquidity to the financial system and induce greater
confidence among lenders. Following the worsening of the financial crisis in September 2008, the
Fed grew its balance sheet by lending to the financial system. As a result, between September and
November 2008, the Fed’s balance sheet more than doubled, increasing from under $1 trillion to
more than $2 trillion.
By the beginning of 2009, demand for loans from the Fed was falling as financial conditions
normalized. Had the Fed done nothing to offset the fall in lending, the balance sheet would have
shrunk by a commensurate amount, and some of the stimulus that it had added to the economy
would have been withdrawn. In the spring of 2009, the Fed judged that the economy, which
remained in a recession, still needed additional stimulus. On March 18, 2009, the Fed announced
a commitment to purchase $300 billion of Treasury securities, $200 billion of Agency debt (later
revised to $175 billion), and $1.25 trillion of Agency mortgage-backed securities. The Fed’s
planned purchases of Treasury securities were completed by the...