Recessions are a normal part of the business cycle, which constitutes of recurring expansion and contraction of the overall economic cycle associated with changes in employment, income, prices, sales and profits. A business cycle consists of four phases, which include peak, recession, trough, and expansion. Once an economy reaches the peak, which is the maximum point of economic growth, it contracts and initiates a period of recession.
Some of the notable recessions in the world history include the great depression of 1930s, which economists attributed to the stock market crash of 1929, and the 1980s recession, which analysts attributed to the shocks in oil prices (Blair 67). The economic recession of 2007 to 2009 was a global crisis that became one of the most hotly debated issues among economists with its detrimental effects spiraling worldwide. Globalization has led to a great interconnection of world economies, and an economic downfall in one part of the world is likely to have spillover effects on almost all other world economies.
The extent of the spillover effects of an economic crisis in one country depends on the size of the economy as evident by the 2007 to 2009 recession, which began due to the dramatic increase in the issuance of highly risky mortgages by American banks and a surge in mortgage defaults (Cline 113). In the early 2000s, the anticipation by households, businesses, banks and other lenders that house prices would increase indefinitely encouraged households to buy highly priced houses as banks and other lender significantly lowered their rates.
In this regard, there emerged various mortgage plans primarily aimed at low-income earners to induce then to buy homes. The collapse of America’s housing market caused a credit crisis, which began a national problem but spilled over to affect the entire world’s economy. The failure by borrowers to meet their monthly payments forced banks to foreclose on their homes. However, the booming housing market of the early 2000s had collapsed, and banks had too many valueless properties, which translated into large write-offs, losses and a global banking crisis.
The underlying cause of the 2007 to 2009 crisis concerns the structuring of the operations of American banks, which limits their ability to hold many of the mortgages they write forcing the banks to bundle them with other mortgages and sell the bundles to other financial institutions throughout the world (Frumkin 78). Therefore, when the sub-prime crisis developed, financial institutions throughout the world realized that a large portion of the bundles of debt that they had purchased were valueless.
As the banks had to write off losses, fear and uncertainty spread regarding banks with bad loans and concerns on the availability of enough capital for banks to pay off debt obligations. Interest rates on inter-bank loans increased as banks became reluctant to lend money to each other, which forced numerous banks to exit the market and initiated a decline in the stock market activity worldwide. Investors transferred their capital resources into haven currencies such as the U. S dollar and Japanese yen forcing many developing nations to seek aid from the International Monetary Fund to offset their financial deficit (Lounsbury and Paul 245).
The financial crisis spread to the emerging economies, which lacked the resources to restore confidence in their financial systems while the underdeveloped countries suffered from a decrease in the foreign aid by wealthy countries. The 2007 to 2009 recession had dramatic effects on unemployment and led to an increase in the unemployment rate from 7percent in 2008 and to around 10 percent in 2009.
In addition, the Economic Policy Institute reported that the number of unemployed adults doubled from 5 percent in 2007 to over 10 percent in 2009 and had detrimental effects such as poor nutrition, health care and lack of stable housing. The loss of purchasing power and tightening credit conditions greatly affected individual’s spending and aggravated health statuses by causing psychological depression and anxiety due to long-term unemployment and lower pay scale, which caused an increased in job dissatisfaction (Sherman 85).
Although global integration of economies enables effective cooperation between countries, it ties world economies closely together and increases the vulnerability of countries to economic downfalls outside their borders. The recession of 2007 to 2009 was a crisis of confidence, which countries can avoid in the future by adopting measures to safeguard institutions that appear to be at a risk and restore confidence in creditors so that they can feel safe when lending to these institutions.
The recession ended in the third quarter of 2009 following the decision by the United States and Europe to finance troubled financial institutions and increment in deposits within banks. Moreover, governments initiated large fiscal stimulus packages such as tax cuts and the International Monetary Fund provided aid to emerging countries to offset their financial deficit. Conclusion The composite index of leading indicators typically foreshadows changes in the direction of the economy while leading economic indicators point to the near occurrence of a recession.
For example, in the early stages of a recession, businesses slow down and the stock market, anticipating lower profits, turns down. In addition, the consumer confidence in the economy begins to sag causing a decline household expenditures. However, even with an evaluation of leading economic indicators, economic fluctuations occur irregularly and are almost impossible to predict with accuracy.