Recession of 2009

Downturns in economic growth rates were apparent early in 2008, and the subsequent intensification of the financial crash of 2008 led to a general expectation of worse to come. The resulting loss of confidence by investors and consumers contributed further to the severity of the reduction in world economic growth, and it was apparent by the end of 2008 that the economies of the United States and several European countries had for some time been in recession. An impending collapse of the international financial system was averted by policy actions introduced in the winter of 2008, but credit availability had been only partly restored by the spring of 2009. The world's economic output is expected to fall in 2009, but assuming the restoration of credit availability in the course of 2009, a gradually recovery is forecast to begin in early 2010.

Supplementary material:

for definitions of terms shown in italics, see the glossary on the Related Articles subpage;

for forecast growth rates, and a summary of recent economic developments see the Addendum subpage;

for a sequential list of events with links to further information, see Timelines subpage; and,

for a selection of economic statistics see the Tutorials subpage.

Origins

Throughout the period from mid-2007 to mid-2008, the growth of the world economy was hampered by increases in oil and food prices, and by a crisis in the financial markets. Oil prices rose from $75 to $146 a barrel and food prices rose sharply, forcing householders to cut their spending on other products. On the financial markets, the subprime mortgage crisis developed into the crash of 2008, as a result of which the availability of credit to households and businesses was curtailed, leading to further reductions in household spending and business investment. In the nine months to the middle of 2008, the advanced economies had grown at an annual rate of only one per cent (compared with two and a half per cent in the previous nine months) and the growth rate of the developing economies had eased from eight per cent to seven and a half per cent. According to the OECD the US economy was by then already facing substantial difficulties. Households had borrowed at an unprecedented rate during the previous 15 years, and their saving rates had fallen nearly to zero as they increasingly relied on housing wealth to finance consumption. With the housing market suffering the severest correction for 50 years, household wealth was declining, and with credit conditions getting tighter, households had been forced to reduce their reliance on borrowing, and job losses and mortgage foreclosures were rising. The prospects of a recession in the United States and of severe reductions in economic growth elsewhere were becoming apparent when the world economy was hit by another shock. The failure of the Lehman Brothers investment bank in September caused a panic in the international banking system that triggered an intensification of the credit shortage to the point at which the world’s financial system appeared to be on the verge of collapse. Massive financial support to their banks by the governments of the industrialised countries averted that collapse, but failed to restore the supply of credit to businesses and householders. By that time, demand reductions had led to reductions in the prices of oil and food, but the resulting relief of the downward pressure on demand was being outweighed by the mounting effects of the credit shortage. By the end of September the United States economy had been in recession for nine months with no apparent prospect of an early recovery and by the end of the year, most of the industrialised countries had suffered reductions in economic activity. It had become evident that a world-wide recession was under way.

Recession in the United States

By early 2009, the United States economy was suffering from a severe lack of demand. Three and a half million jobs had been lost in just over a year and businesses were responding to falling demand by laying off workers or cutting back on their hours or wages, causing families to further reduce their demand and businesses to respond with yet more layoffs and cutbacks. The problem was being made worse by the inability of the financial system to provide the credit necessary for recovery, and the resulting "credit crunch" was causing more job losses and further declines in business activity, which, in turn, was adding more pressure on the financial system. Two and a half million families had faced foreclosure in the previous year, and the reductions in personal wealth resulting from the fall in house prices were causing further reductions in demand. Reports from the twelve Federal Reserve Districts in March suggested that national economic conditions deteriorated further during the reporting period of January through late February. Ten of the twelve reports indicated weaker conditions or declines in economic activity. The deterioration was broad based, with only a few sectors such as basic food production and pharmaceuticals appearing to be exceptions. Looking ahead, contacts from various Districts rate the prospects for near-term improvement in economic conditions as poor, with a significant pickup not expected before late 2009 or early 2010. The availability of credit generally remained tight. Lenders continued to impose strict standards for all types of loans, with scattered reports of further tightening and particular scrutiny focused on construction projects and commercial real estate transactions.

The international recession

World

In early 2009, economists at the IMF reported that, although policy actions had helped avert a global financial meltdown, credit conditions were still seriously impaired. Policy actions to resolve the financial crisis had not yet achieved a decisive breakthrough, and although conventional monetary easing had achieved some improvement, direct intervention in credit markets had become necessary, leading to large increases in the liabilities of central banks. The IMF economists now expect world growth to decline sharply from 3½ percent in 2008 to ½ percent in 2009 — with a gradual recovery to around 3 percent in 2010, but only if there is further urgent action to tackle financial problems and to support domestic demand.

United Kingdom

The International Monetary Fund expects the recession in Britain to be more severe than elsewhere in Europe because of the greater openness of its economy and the greater influence of its financial and housing sectors. However its Deputy Managing Director has expressed confidence that the policy actions that have been taken will achieve recovery . Its lower levels of national debt compared with other European economies had provided greater scope for fiscal expansion than elsewhere in Europe and early expansionary measures were undertaken. Britain's public debt is expected to rise above its 2007 level of 43 per cent of GDP (compared with a 78 per cent average for the advanced G20 economies) to about 77 per cent in 2014.

Asia

Japanese Industrial production in January was 10.0% lower than in the previous month (the fourth successive month fall} - to a level 30.8% below that of January 2008 .

Developing countries

According to a World Bank report published in March 2009, 94 out of 116 developing countries have experienced a slowdown in economic growth. Of these countries, 43 have high levels of poverty. To date, the most affected sectors are those that were the most dynamic, typically urban-based exporters, construction, mining, and manufacturing.

International coordination

A G20 summit meeting of the world leaders took place in Washington on 15th November, with the purpose of agreeing a coordinated response to the financial crisis. An ebook was published in advance, with the recommendations of an international group of twenty leading financial economists. They were unanimous on the need for Governments to take urgent action to recapitalise their banks, to guarantee cross-border bank claims, to restructure nonperforming assets, and to extend financial support for crisis countries. They were also agreed on the need for immediate, substantial, internationally coordinated fiscal stimulus, tailored to the circumstances of each country and taken with a view toward the impact on the rest of the world. There was also unanimity on the need to augment IMF resources immediately so that the institution has adequate firepower, and on the need to strengthen existing arrangements for global governance. Several of them also argued for new approaches to the regulation of large cross-border financial institutions.

Policy debate

Overview

As the recession deepened, budget deficits widened, mainly as a result of the operation of automatic stabilisers, but also as a result of discretionary fiscal stimuluses. A widening conflict has developed between those who fear that the resulting fiscal expansion may be insufficient to counter growing output gaps - and those who consider fiscal policy to be unnecessary or ineffective - or who fear the possibility of sovereign default. Among the first group were the Nobel prize-winners Paul Krugman , and Joseph Stiglitz . Among the others, a group of eminent British economists advised that "occasional slowdowns are natural and necessary features of a market economy" and that "insofar as they are to be managed at all, the best tools are monetary and not fiscal ones".

The case for fiscal expansion

By October 2008, policy-makers in most industrialised countries had accepted that in order to avoid the development of persistent and unmanageable deflation such as occurred in the pre-war great depression, early corrective action would have to be taken, going beyond the necessary restoration of activity in the financial system. Most countries had long abandoned the use of reductions of taxation and increases in public expenditure to ward off economic downturns in favour of the use of interest rate reductions , but there were doubts whether monetary policy would be sufficiently powerful, or sufficiently quick-acting in view if the severity and imminence of the current deflationary threat. In the United States, in particular, the federal interest rate had already been reduced to 1 per cent - leaving little scope for further reductions, and banks there and elsewhere had become reluctant to pass on central bank reductions of interest rates.

The consensus view among economists, as expressed by the Chief Economist of the OECD is that :

Against the backdrop of a deep economic downturn, additional macroeconomic stimulus is needed. In normal times, monetary rather than fiscal policy would be the instrument of choice for macroeconomic stabilisation. But these are not normal times. Current conditions of extreme financial stress have weakened the monetary transmission mechanism. Moreover, in some countries the scope for further reductions in policy rates is limited. In this unusual situation, fiscal policy stimulus over and above the support provided through automatic stabilisers has an important role to play. Fiscal stimulus packages, however, need to be evaluated on a case-by-case basis in those countries where room for budgetary manoeuvre exists. It is vital that any discretionary action be timely and temporary and designed to ensure maximum effectiveness.

In its 2008 World Economic Outlook, the International Monetary Fund has also noted that fiscal policy can quickly boost spending power, whereas monetary policy acts with long and uncertain lags , and a 2009 IMF Staff Position Note demonstrates that an internationally coordinated programme of fiscal expansion, combined with accommodative monetary policies, can have significant multiplier effects on the world economy .

The need for fiscal space

However, the IMF also advise that a fiscal stimulus can do more harm than good if it makes debt unsustainable, and suggest (in another note) that further stimuli should be confined to countries with more fiscal space to expand, such as (the United Kingdom, China, France, Germany, and the United States) , as compared, for example with Japan and Italy. In another paper they warn that a spread in fears of government insolvency could hamper recovery. A perceived risk that governments find it more convenient to repudiate their debt could lead to an increase in the cost of borrowing that could further add to government debts in an unstable "snowballing" effect. The IMF have noted some signs of an increase in such fears and, although the perceived risk is so far small, they consider it important that governments should reassure markets that fiscal solvency is not at risk by presenting their fiscal policies in medium-term frameworks that envisage a gradual fiscal correction as economic conditions improve.

Objections

Professor Eugene Fama of the University of Chicago argues that consumers do not respond to tax cuts because of awareness that they will eventually be paid for by tax increases (the argument known to economists as Ricardian Equivalence). He also argues that all forms of fiscal stimulus are ineffective because they merely move resources from private investment to government investment or from investment to consumption, with no effect on total current resources in the system or on total employment (the argument known as crowding-out). Others have argued that the danger of incurring unsustainable debt , makes fiscal stimulus a risky option, especially for countries with high levels of national debt. There have been warnings of resulting disaster, even for countries with modest ratios of national debt to GDP. Britain's Shadow Chancellor, for example, has described a fiscal stimulus as "exactly the wrong approach" that could itself cause a decade-long economic slump and Germany's Finance Minister described British plans for financial expansion as "crass Keynesianism" .