Answer to Question #283715 in Macroeconomics for ABEX

Question

17. In the year 2008, the world economy experienced a recession.

(a) What was the major cause of the recession?

(b) What similarities can you observe with the recession of 1930s?

(c) Many countries such as the US, Germany, Japan, and China have taken bail-out measures to help the economy recover. Demonstrate the results of the actions using your knowledge of IS-LM framework.

(d) What impact had the recession on developing countries? Through what channels does the recession affect these countries?.

Answer 1

17.

a)      The cause of the great economic recession in 2008 was caused by the collapse of the housing market. During the early to mid-2002 the housing market was a boom. Therefore, to capitalize on it, mortgage lenders rushed to approve as many home loans as they could including that of borrowers with less than deal credit. They were termed subprime mortgage loans. The subprime mortgage loans became toxic when most people defaulted, in paying it, which led to credit crunch in global banking system and a precipitous drop in bank lending. The net worth of the households in U.S. declined erasing $19.2 trillion. The loaning process was so unregulated that it was nicknamed NINJA loans; abbreviations for no income, no job, no assts.

 

b)     The similarities between the great recession of 2008 and 1930s is that in both scenarios, the aggregate demand (AD) declined. During the great recession, the financial crisis led to a breakdown in the loanable funds market resulting in the reduced funding opportunities for investment for companies, which reduced the long-run aggregate supply. Additionally, large decline in consumer wealth contributed to a significant decline in aggregate demand. During the great depression in 1930s, there was a significant decline in aggregate demand which was as a result of faulty macroeconomic policies.

 

c)      The IS-LM graph shows an intersection of goods and the money market. The IS represents Investments and Savings while the LM represents Liquidity and Money. In August 2007, the Federal Reserve responded to the subprime mortgage crisis by adding $24 billion n liquidity to the banking system. By September 2008, the Congress approved $700 billion bank bailout known as the Troubled Asset Relief Program. Additionally, Obama proposed h $787 billion economic stimulus package. Which helped prevent the global depression.

 

d)     The 2008 recession impacted developing countries in the following ways:

·        Foreign direct investment declined especially access to loans from foreign banks. So developing countries had to set up their own wealth funds to offset the situation.

·        There was a decline in the export revenue due to lower demand and reduced prices of commodities

·        There was a recession in global tourism which is often a significant share of GDP for developing nations

·        A decline in remittances from overseas migrants working in the developed countries. Because most people working in countries would send some of their income to home countries.

·        Some countries were hit by many macroeconomic shocks. For instance, Nigeria whose export revenue declined following a 70% fall in crude oil prices, a fall in domestic share prices which both contributed to depreciation of the naira by 20% which in return worsened terms of trade, increased the costs of servicing foreign debts and increased prices of imported foods.