Economy

The recent recession has brought an increase in unemployment as well as a sharp decrease in income, output, and world trade, in developed and underdeveloped countries (Georg, 2009). So this paper addresses the question: Is the result of the credit crunch a recession or a depression. First, the paper describing the definitions of a recession and a depression is using relevant examples. Second, this paper illustrates the differences between them by using the Great Recession beginning in 1929 with the Crash on Wall Street and into the 1930s with the double-dip. Finally, this paper reflects any similarities and/or differences between the events leading up to the Great Recession and those of the Great Depression. According to NBER’s (2010), the definition of recession is a significant decline in economic activity spread across the economy and last more than a few months to more than a year, normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales. It begins just after the economy reaches a peak of activity and ends as the economy reaches its trough (NBER’s, 2010). The definition of economic depression is simply a recession that lasts longer and has a larger decline in business activity (Moffatt, not dated). Georg (2009) stated that the Great Depression is an archetypal example of a depression which in terms as a severe recession, while a recession is defined as a period of cut of incomes and unemployment rate rose. According to Moffatt (not dated), the changes in GDP was a good rule of thumb for determining the difference between a recession and a depression, normally real GDP declines by more than 10 percent during a depression. Moffatt (not dated) stated that the Great Depression of the 1930s can be seen as two separate events: an incredibly severe depression lasting from August 1929 to March 1933 where real GDP declined by almost 33 percent; then another less severe depression of 1937-38 where real GDP declined by 18.2 percent. Moffatt (not dated) also claimed that the worst recession in the past 60 years was from November 1973 to March 1975, where real GDP declined to 4.9 percent; the United State has not had anything even close to a depression in the post-war period. According to Goldman (not dated) during the Great Depression the economic declined 26.5 percent but there was 3.3 percent drop in GDP that took place between second quarter 2008 and first quarter 2009. Comparing the unemployment rate, there was 25 percent during the Great Depression but 8.5 percent during the Great Recession (Goldman, not dated). During the Great Depression half of the banking industry failures compared with the Great Recession there was 0.6 percent bank failures only (Goldman, not dated). According to Gascon (2009), the failure of major investment banks and the largest commercial bank as well as a sharp decline in consumer spending are the similar events comparing the Great Depression and the Great Recession. However, by learning mistake from the past, the financial institutions designed to prevent banking collapses and substantial action by policymakers make these two episodes very different (Gascon, 2009). Romer (2003) argues that 1929 Crash on Wall Street and the Great Depression were two separate events although the decline in stock prices was main factor that caused the halt to both in production and in employment in the United States. According to Georg (2009) the debts defaulted due to the farmer’s land was over mortgaged and when the commodity prices declined due to large international imports, it made it difficult for farmers to keep up with their loan payments. The increased demand for savers to withdraw their savings, many banks went bankrupt, the authorities appeared unable to stop bank runs and households lost their faith in the banking system, consequently the financial industry failure was the most powerful cause of economic depression (Georg, 2009). Consequently, the economy during the Great Depression experienced huge amounts of bad loans and liquidity dried up, savers lost savings, bank reduced lending so consumer spending and investment fell dramatically; these worsened the effect of the crisis (Georg, 2009). It is vitally important to have a strong financial system (Georg, 2009). If the financial market is illiquid, the firm in the economy typically postpone hiring and investment decisions because it is expensive to make hire or investment mistakes (Bloom, 2008). If every company in the economy directly cuts back on investment and employment decisions then the economy activity slows down; this directly affects the two main drivers of economic growth and knock-on effects in depressing productivity growth (Bloom, 2008). On the consumers’ side also create similarly damaging effect; people avoid buying durables goods like cars, TVs and so on (Bloom, 2008). This is the same for the Great Recession, where United States home prices declined due to weak economic conditions has created mortgage loans defaulted (Georg, 2009). The United State mortgage lenders sell many inappropriate mortgages to customers with low income and poor credit hopefully it could boom the housing market; the credit crunch was driven by a sharp rise in defaults on subprime mortgages (Finance Blog, 2008). The crisis worsened with the fall of big institutions such as Bear Stearns, Fannie and Freddie Mac, Lehman Brothers and American International Group (AIG) then turned liquidity crisis into a full-fledged global credit crunch as interbank lending effectively seized up on the fear that no banks were safe(Bordo, 2008). The stock markets declined sharply on the news as well as consumer and investment expenditures (Bordo, 2008). The United State Treasury sponsored its Troubled Asset Relief Plan (TARP) whereby $700 billion could be devoted to the purchase of heavily discounted mortgage hopefully restore bank lending (Bordo, 2008). The UK authorities responded by pumping equity into British banks, guaranteeing all interbank deposits and providing massive liquidity as the global interbank market ceased functioning; the EU countries responded in kind (Bordo, 2008). These rescue plans may solve the solvency crisis are similar to the RFC in the United State in the 1930s and the Swedish and Japanese rescues in the 1990s (Bordo, 2008). The subprime mortgage papers were sold around the globe during the Great Recession soon the crisis became an international twist, it has forced Iceland three of the major banks had problems to refinance their short term debt and collapsed; two of the largest banks collapsed in Belgium, Fortis and Daxia (Georg, 2009). Northern Rock also suffered to raise enough funds in the usual capital market when the subprime crisis hit, eventually had to make step to ask the Bank of England for emergency funds; as a result of credit crunch, risky mortgage products like 125 percent mortgage have been removed from the market (Finance Blog, 2008). The collapsing equities market and virulent credit crunch which will likely produce a significant recession into the real economy (Bordo, 2008). The differences between both events is the interest rate, the Great Recession emerged the interest rates were at a relatively low level and even lower during the crisis, while in the Great Depression the Fed raised interest rates; the economy fell into a recession consequently (Georg, 2009). In conclusion, the risky and inappropriate business models of banks that invested in unsustainable businesses are the cause of the both the Great Recession and the Great Depression (Georg, 2009). The collapsing equities market and virulent credit crunch and the failures of the financial industry paralyze the real economy (Georg, 2009). A strong financial system is vitally important for a stable economy, the economy flourish only if the market functions well; financial market liquidity, firms able to invest, expand their capacity, create new jobs, pay their workers; thus consumer able to spend (Georg, 2009). Reference Lists Georg, S. November 24, 2009. Can Great Depression Theories Explain the Great Recession' A European Business School, Oestrich-Winkel at http://mpra.ub.uni-muenchen.de/19781/ Moffatt, M. (not dated). Recession' Depression' What’s the differences' At http://economics.about.com/cs/businesscycles/a/depressions.htm NBER’s Business Cycle Dating Committee, September 20, 2010 at http://www.nber.org/cycles/recessions.html Bloom, N. Spring 2008. Will the credit crunch lead o recession' At http://www.stanford.edu/~nbloom/CreditCrunch.pdf Goldman, D. (not dated). Great Depression vs. ‘Great Recession’: Comparisons between this economic recession and the Great Depression are common, but the granddaddy of all downturns was far worse, at http://money.cnn.com/news/storysupplement/economy/recession_depression/ Romer, C. D. November 23, 2003. Great Depression at http://elsa.berkeley.edu/~cromer/great_depression.pdf Bordo, M. D. November 6, 2008. An Historical Perspective on the Crisis of 2007-08 at http://michael.bordo.googlepages.com/An_Historical_perspective.pdf Finance Blog, March 12, 2008. Credit Crunch Explained at http://www.mortgageguideuk.co.uk/blog/debt/credit-crunch-explained/ Gascon, C. S. April, 2009. This is Not Your Father’s Recession … or Is It' At http://stlouisfed.org/publications/re/articles/'id=1250#sidebar