The period from 2007 to 2008 marked as the period of Financial Crisis and is considered as first contraction of global economy after the period of Second World War (Aguiar, Hurst and Karabarbounis, 2013). Many economies were affected by this Financial Crisis and sluggish recovery was observed subsequently (Lo and Rogoff, 2015. This recession period was observed to be different from prior recessions, since it marked simultaneous changes in the stock market, labor market and housing market (Jenkins, 2012).
Along with other countries, USA was also affected due to this financial crisis. The degree of loss for the economy was much higher, all the economic indicators of welfare was affected by this crisis (Riumallo-Herl, 2014).Affected indicators of the economy in turn hindered the growth of the economy which resulted in negative GDP rate of the economy (Del Negro , Giannoni and Schorfheide, 2015).
The aim of this paper is to explore the main causes behind the great recession that occurred in 2007-2008 in USA. Paper focused on the causes and their effect on economy. Development indicators are considered in this paper and these includes- GDP, unemployment and pattern of trade (Morse, 2014).
Various methods can be used to understand the degree of loss incurred by USA economy, business cycle is one such method that is used to interpret the phase through which the economy passes over time.
In order to understand the cause of recession the main origin behind this cause is very important to be considered. Business cycle shows the fall and rise of economic growth in an economy. This cycle is mainly used for evaluating the performance of the economy and thus helps in reaching optimal financial decisions for an economy. The reason behind occurrence of recession is best understood by considering this business cycle. There are four phases present in an business cycle and these incorporates-the first phase which shows expansion of economy, the second phase which shows economy at its peak, the third phase is the situation of contraction in an economy and finally the fourth phase shows the trough situation faced by an economy (Gabisch and Lorenz, 2013). Business cycle stages are determined by National Bureau of Economic Research using the quarterly GDP growth rates; it also uses economic indicators which are employment, industrial output, real income and retail sales (Ball, 2014).
Figure 1: Business cycle
The graphical representation of business cycle shows the movement of the cycle more clearly. It is represented below. The figure below shows the curve which explains the business cycle at its four phases.
Figure 2: Four phases of business cycle
The above figure shows the economic activity over time. The economy starts from trough or depression where the level of economic activity is at lowest level. With the recovery of economic activity the economy moves to the expansion phase, the expansion cannot persist and after reaching peak, contraction phase starts. The contraction phase when gathers momentum, we have a depression. The downswing of the cycle continues till the lowest point reached from where the economy starts. In this way cycle is completed (Gabisch and Lorenz, 2013).. However, after remaining at the trough phase for some period of time the economy starts to revive and starts a new cycle. Expansion in population and the development of capital produce economic growth. A reduction in overall business activity can result in an economic contraction, or recession (Ball, 2014).. A recession is a stage of economic contraction, where the gross domestic product decreases. The main characteristics of recession are- expansion of unemployment, slumping sales, increased business failures, lower level of income and increased underemployment.
Considering this business cycle recession in USA can be shown. In 2008, USA economy contracted to 2.7 percent in the first quarter of 2008. In the second quarter the economy rebounded to 2 percent again another contraction took place which resulted in 1.9 percent in the third quarter however in the fourth quarter the economy reached to 8.2 percent. In 2009, USA economy again contracted in the first quarter with 5.4 percent and for this unemployment rate within economy increased. In the second quarter of 2009, USA economy reached the trough phase with contracted GDP of 0.5 percent and unemployment rate again increased. However, the expansion phase started in the third quarter of 2009 where the GDP increased to 1.3 percent. This expansion mainly occurred due to spending amount received by the economy through American recovery and Reinvestment act. But unemployment rate didn’t recovered it remained at an increased level (Eaton, 2016).
A worldwide economic complexity experienced by markets and consumers is termed as global financial crisis. A global financial crisis is a complicated business environment to achieve something in because potential consumers tend to decrease their purchases of goods and services until the economic situation improves.
The global financial crisis of 2007 to 2008 started to show its effects in the middle of 2007. During this period around the world stock markets have fallen, financial institutions collapsed and nations have had to come up with packages that will rescue economy by bailing out their financial systems. This crisis mainly affected the economy’s growth process and the domains where it affected most are shown below.
USA housing bubble was a real estate bubble and it affected half of the economy. The market for housing peaked in 2006(Leamer, E.E., 2007). . Later the market crashed in 2007 and caused financial crisis. The reason behind this bubble was the Federal Reserve and banks that provided loans at ease and reason behind providing loan was, this housing market was identified as wealth generator. The problem mainly arised when some types of subprime loans failed to pay back, and as a result of availability of loans to purchase house increased, on other hand the price of houses decreased drastically. In 2007 credit market froze and the condition deteriorated. Subprime credit stopped and federal fund rate for credits of other borrowings increased (Leamer, E.E., 2007).
Figure 3: Price of houses
Source: (U.S Census)
The above figure shows the year 2005 to 2006 house prices was at its peak then gradually it began to fall, and the main reason this fall was availability of loans from bank.
A sudden decline of stock prices across stock market is termed as stock market crisis. Crisis mainly occurs due to extreme economic optimism, extended period of rising stock prices and wide use of margin profit and leverage by market participants. Stock markets generally behave according to log normal distribution(Bodie, 2013).
Failure of massive financial institutions in USA devolved into a global financial crisis. The institutions in USA faced failure because to increased number of subprime loans and credit defaulters.
Figure 5: Stock market prices
Source: (DJIA)
The figure above shows that US stock market peaked in 2007 and then it declined . This fall in prices was a drastic one during this period.
Credit default is a financial swap agreement that a seller of CDS will pay compensation to the buyer in the event of a loan or other credit event (Bodie, 2013).
CDS contributed significantly to financial crisis in 2007; however the CDS market worked well during this crisis. This was done by making the market for CDS fairly liquid. Market also handled large defaults like Lehman brothers. Lehman brothers collapsed during the financial crisis but however were protected by CDS (Quax, Kandhai and Sloot, 2013).
Dumping is defined in the General Agreement on Tariffs and Trade and it mainly shows product introduction of one country into the commerce of another country available at below normal value of the products. China’s name comes first when dumping is considered (Dongkun, 2012).
Due to dumping from China, US firms incurred losses at a higher level and this resulted in financial crisis in USA in 2007. Chinese industries dumped US industries at a high level. Steel industry was mainly affected due to dumping.
Figure 6: Dumping
Source: (IIT policies)
The above figure shows the before and after case of anti dumping. After the imposition of anti dumping policies share of production is stabilized.
GDP is considered to be a vital aspect of growth. For showing economic growth this plays an important role. It mainly consists of the incoming part of economic activities (Stockhammer, 2012). For showing the performance of a country over the years GDP acts as a significant element.
Figure 7: USA GDP
Source: (OECD)
The above figure shows the GDP of U.S over the years 2005 to 2009. This period is chosen to show the effect of financial crisis in a clear manner. The figure shows that period of financial crisis recorded negative growth in USA and all these was due to events that negatively affected the economy(Del Negro , Giannoni and Schorfheide, 2015). The period after crisis also recorded negative growth and this was due to sluggish recovery of the economy (Stockhammer, 2012).
Unemployment in a country mainly shows the amount of population looking for jobs. This amount also reflects the degree of non availability of jobs for the active population. Unemployment is mainly outcome of various events that occur within country. During the period of financial crisis, USA labor force faced huge unemployment, even number of working population reduced because of layoffs (Shimer, 2012).
Figure 8: Unemployment rate
Source: (US Bureau of labor statistics)
The unemployment rate is shown in the above figure. The rate is considered from 2006 to 2009 that is pre financial crisis to post crisis. The figure shows that the number the unemployed was moderate first quarter of 2007 after that the rate began to increase and it increased at a high level. Post the crisis period the economy was unable to cope up with the growing unemployment rate as the number increased by the concerned authorities in order to tackle the problems that were outcome of financial crisis (Shimer, 2012).
Trading pattern is considered as another indicator to assess the performance of an economy. It mainly shows the export and import of any country. USA economy along with other aspects was affected in their trading pattern also.
Figure 9: Balance of trade
Source: (US Census)
The trading pattern of USA is shown in the above figure. It can be seen that the economy faces deficit in budget and for this negative result are obtained over the period from 2006 to 2009. Thus negative trade result mainly owe to dumping from China, thus financial crisis period is not an exception with respect to trading pattern of the economy. Pre crisis and post crisis the economy faced negative balance of trade (Obstfeld, 2012).
Conclusion
The conclusions drawn from the above study consist of various aspects of the financial crisis. . USA being a developed country was affected by global financial crisis in a large scale and the main causes behind this are :housing market bubble which is the core element of driving the financial crisis within the economy and not only these housing market bubble influenced other countries also to face financial crisis. Although, the main reason behind this housing bubble market is Government itself which encouraged to engage in credit activities as the view of government was to increase the wealth of government revenue that is generated from housing market. Other causes such as stock market crash, credit default and dumping from China also played important role behind creation of financial crisis.
Thus period of financial crisis from 2007 to 2008 is a remarkable one for USA, as the economy faced severe problems during this period and the growth of the economy after the period of financial crisis was a sluggish one as it took time for the economy to recover its losses at the cost of things.
References
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Ball, L.M., 2014. Long-term damage from the Great Recession in OECD countries (No. w20185). National Bureau of Economic Research.
Bodie, Z., 2013. Investments. McGraw-Hill.
Del Negro, M., Giannoni, M.P. and Schorfheide, F., 2015. Inflation in the great recession and new keynesian models. American Economic Journal: Macroeconomics, 7(1), pp.168-196.
Dongkun, L., 2012. The 10th Anniversary of China’s WTO Accession: Research on Security Relations between Anti-dumping and China’s Import and Export Industry [J]. Journal of Shandong Youth University of Political Science, 1, p.028.
Eaton, J., Kortum, S., Neiman, B. and Romalis, J., 2016. Trade and the global recession. The American Economic Review, 106(11), pp.3401-3438.
Gabisch, G. and Lorenz, H.W., 2013. Business cycle theory: a survey of methods and concepts. Springer Science & Business Media.
Jenkins, S.P., Brandolini, A., Micklewright, J. and Nolan, B. eds., 2012. The great recession and the distribution of household income. OUP Oxford.
Leamer, E.E., 2007. Housing is the business cycle (No. w13428). National Bureau of Economic Research.
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Obstfeld, M., 2012. Financial flows, financial crises, and global imbalances. Journal of International Money and Finance, 31(3), pp.469-480.
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Stockhammer, E., 2012. Rising inequality as a root cause of the present crisis. Political Economy Research Institute Working Paper, 282.
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