Understanding Economic Recessions: Causes and Effects - Essay Sample

Introduction

Economic recession refers to a period when the economy of a country significantly declines for two consecutive quarters (six months) or longer. Recession is measured or marked by macroeconomic indicators such as gross domestic product (GDP), business profits, unemployment rate, income, investment spending and capacity utilization. (Grusky 4). There have been numerous recessions in the United States dated back in the 19th -century which have increasingly affected worldwide economies. All sectors of the economy feel impacts of recession from small to big businesses, private to public, government agencies etc. The Great Recession in the United States history lasted from 2007 to 2009 which is believed to have been caused by extensive failures in financial regulation and lack of full understanding of financial systems (Grusky 8). A severe economic and social crisis accompanied the recession with the rate of unemployment rising, bankruptcies of many companies and banks, closure of businesses due to excessive borrowing and recklessly taking too many risks. It took several years for the US economy to recover from the pre-crisis marking it the worst economic downturn after the 'Great Depression' recession of the 1930s. Although the recession is a short terms aspect of the economy, its consequences are severe and can last for a long time if corrective measures are not taking in time (Grusky 4). This paper will assess the different impacts of the great recession of 2007 to 2009 to the American people, economy and the institutions and the various factors that made the situation worse and unmanageable.

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The Keynesian Theory

The Keynesian theory of economics was developed by John Maynard Keynes which was used to understand the causes of the great depression. The theory primary concept is that aggregate demand played a significant role in setting up a chain of reaction which results in an economic recession (Schlenkhoff 10). As such, in the middle of economic recession, the Keynesian theory points out to the role of output, spending and inflation co-actively in causing economic slump which affects the economy in terms of employment, earnings, and cost of goods. At the middle of the recession is the aggregate demand which declines results in further economic extremities such as reduced government spending, poor sales by businesses, deflation, and unemployment as companies seek to reduce costs and survive the low consumer spending (Schlenkhoff 13).

Factors that Contributed to the Recession

Three factors led to the great recession in the US. Although each element by itself could not have significant effects, the three combined were rather explosive. The first was a decline in house prices that began in the summer of 2007. Before the summer of 2007, the housing bubble had been a critical driver of the economy, pushing the construction of the residential houses to a record high as a share of GDP (Smeeding 14). The demand for residential houses led to a consumption boom. People invested heavily on this boom; thus the saving rate reached a record low. When the bubble burst, it was inevitable that these sources of demand would disappear and there were no better alternatives to replace them apart from deficits of the government budget. The second factor was that the financial systems had heavily invested in the housing-related assets, mortgage-backed securities (Grusky 7). Financial systems were profoundly affected since it emerged that after a decline in house demand, prices were being driven in part by questionable loans. The financial industry widely touted the fact that lenders were issuing loans to people who had not previously been eligible. The fact that many of these loans involved little or no down payment contributed significantly to the fall of financial systems. The third factor was that the shadow banking system was invested in housing assets and highly vulnerable to bank runs. The shadow banking systems lacked the traditional deposit insurance or lender of last resort measures to protect them from this run. When the housing prices went down, many people withdrew their funds and thus rendered the banks bankrupt (Smeeding 28). This panic in various parts of the shadow banking system fueled a credit crunch in the real economy, forcing much business to scale back by laying off of some of their employees and cut on spending which helped lead to a recession.

High Unemployment and Job Loss

One of the significant impacts of the great recession to the United States was high unemployment. The recession impact on employment in the United States was so severe that unemployment persevered long after the recession had subsided. The recession of 2007 to 2009 was one of the major economic events in United States history since the great depression of the 1930s. During the 2007 to 2009 recession which lasted for eighteen months and led to the decline of jobs by 6% (Kalleberg and Von Wachter 6). During the depression the National Bureau of Economic Research shows that over 30 million Americans lost their jobs and long term unemployment continued. Job loss during the great recession of 2007 to 2009 was due to the decline in the consumer power and demand of products which forced many companies to retrench employees and also to refrain from hiring new employees. The loss of wages due to job loss led to the sustainability of the high level of unemployment due to the decreasing consumer purchasing power (Kalleberg and Von Wachter 18). The African Americans during the recession were worst affected by the recession in terms of unemployment. Due to unemployment, many Americans slumped to the poverty level in which families and communities were affected. Individuals who became unemployment during the recession endured a spell of unemployment for longer than 26 weeks (Grusky 18).

Recession Led to the Decline of Earnings and Consumer Spending

Apart from losing jobs, those that were retained by organizations faced significant salary cuts, and as a result, many people resulted in borrowing which further increased poverty and the poor state of living for many Americans. Apart from the decline of earnings workers who were entering the market at the time had to settle for low paying jobs irrespective of their job qualifications (Grusky 8). The decline of earnings during the great recession forced many people out of their homes due to the inability to pay rents. Many families accumulated debt during the recession and most in the middle class fell into poverty level because they had not accumulated enough to survive during the recession (Grusky 9). The reduction in earnings had a resulting negative impact on businesses due to the decline in sales as consumer buying power declined further during the recession which also led to household suffering due to loss of jobs and organizations were forced to maintain low salaries with the aim of reducing their cost of business which was critical to their survival during the recession.

The Great Recession Led to Further Racial and Ethnic Inequalities

Before the 2007 to 2009 recession inequalities and differences existed between the whites and the non-whites as well as low-income earners and the high-income earners. The great recession further widened the rift between races with the most disadvantaged being the low-income earners and the majority of them are the non-whites who were already disadvantaged before the recession (Smeeding 12). The white communities were less affected by the recession because they already harbored wealth that was used to cushion them during the recession. Families from non-white families found it more difficult to pay their houses, meet daily needs such as food and also access quality healthcare. During the great recession, the African Americans and the Latino families were more likely to default paying their mortgage and also to experience home foreclosures (Smeeding 18). Besides, it was noted that the minorities were more likely to be laid off by companies compared to the white. Although the minorities managed to gain work in the post-recession period, they were paid lower wages, and the security of employment for the communities of color significantly declined.

Housing Crisis

The housing market started booming in the late 1990s and continued to expand through 2004 and 2005. Just before the fall, real home prices increased by 49 percent in Las Vegas in 2004, by 43 percent in Phoenix in 2005, and by over 60 percent in Miami throughout 2004 and 2005. The demand for residential houses led to a consumption boom. People invested heavily on this boom; thus the saving rate reached a record low. After the bubble burst, home prices around the country fell significantly. From their peak in May 2006 to their trough in May 2009, real housing prices fell by about one-third across the nation, and in some cities, such as Las Vegas and Phoenix, they fell by more than 50 percent (Kalleberg and Von Wachter 13). The collapse of housing prices was linked to the inability to repay mortgages. Property foreclosures more than doubled through 2007, and foreclosure activity continued to increase through 2008 and 2009.

The Collapse of Financial Institutions

The financial systems had heavily invested in the housing-related assets, mortgage-backed securities. Financial systems were profoundly affected since it emerged that after a decline in house demand, prices were being driven in part by questionable loans. The fact that lenders were issuing loans to people who had not previously been eligible was widely touted by the financial industry (Schlenkhoff 14). Many of these loans involved little or no down payment, this, therefore, contributed significantly to the fall of economic systems. When the housing bubble burst, investors found that mortgage-backed securities were much riskier than advertised, and both European and American financial markets tightened as these toxic assets quickly became untradeable. This thus led to the fall of some investment banks such as Lehman Brothers which became bankrupt, unable to borrow or to sell its toxic assets. Due to the financial hardship that the government was going through, it was unable to chip in and save the particular bank from collapsing.

The Decline in Consumer Spending

During the great recession, one in every five employees lost their jobs. Many of those workers never recovered. They never got real work again. The young people entering the job market were significantly disrupted by the recession (Schlenkhoff 10). The Great Recession accelerated several trends and dwindled the development of others. The fact that so many people took temporary jobs, often as contractors, was pushed along by the downturn, in part, because employers were so unsure about the future but also because workers had no choice but to take them. This meant that many households had to cut down their expenditure as there was little if not no disposable income. Consumer spending drives more than two-thirds of the US economy (Smeeding 12).

The Decline in Government Spending

During the recession period, the US government was forced to cut down on its expenditure. This was greatly attributed to low taxes that were being collected at the time. Many people who had been contributing tax income to the government lost their jobs. Besides, some businesses were forced to shut down as the cost of production went high (Schlenkhoff 11). Moreover, the wages of the employees in these businesses, decline in sales and losses further pushed the companies to stop being operational as they could not keep up with the expenditure. This, therefore, reduced the amount of money that the government was receiving as the income tax.

Deflation

Deflation typically occurs in and after periods of economic crisis. When an economy experiences a severe recession or depression, economic outp...