Origin Impact

As noted, most major financial crises in the past were preceded by a sustained period of buoyant credit growth and low risk premiums, and this time is no exception. Rampant optimism was fuelled by a belief that macroeconomic instability was eradicated. The 'Great Moderation', with low and stable inflation and sustained growth, was conducive to a perception of low risk and high return on capital. In part these developments were underpinned by genuine structural changes in the economic environment, including growing opportunities for international risk sharing, greater stability in policy making and a greater share of (less cyclical) services in economic activity. Persistent global imbalances also played animportant role. The net saving surpluses of China, Japan and the oil producing economies kept bond yields low in the United States, whose deep and liquid capital market attracted the associated capital flows. And notwithstanding rising commodity prices, inflation was muted by favourable supply conditions associated with a strong expansion in labour transferred into the export sector out of rural employment in the emerging market economies (notably China). This enabled US monetary policy to be accommodative amid economic boom conditions. In addition, it may have been kept too loose too long in the wakeof the dotcom slump, with the federal funds rate persistently below the 'Taylor rate', i.e. the level consistent with a neutral monetary policy stance(Taylor 2009). Monetary policy in Japan was also accommodative as it struggled with the aftermath of its late-1980s 'bubble economy', which entailed so-called 'carry trades' (loans in Japan invested in financial products abroad). This contributed torapid increases in asset prices, notably of stocks and real estate – not only in the United States but also in Europe.A priori it may not be obvious that excess global liquidity would lead to rapid increases in assetprices also in Europe, but in a world with open capital accounts this is unavoidable. To sum up,there are three main transmission channels. First, upward pressure on European exchange rates vis-à-vis the US

we are in a recession – is going to last a long time and will likely lead to a great deal of pain in the short-term. First things first – let’s talk about how we got here and why is it going to be so bad. Americans have gradually moved away from their financial roots — which are based in saving money — and in 2005 and 2006. without entailing any upward tendency in inflation of consumer prices to speak of. is debt. and perhaps most importantly. The answer. So it is not surprising that money stocks and real estate prices soared in tandem also in Europe. The Recession – Short Term Pain.dollar and currencies with defacto pegs to the US dollar (which includes interalia the Chinese currency and up to 2004 also the Japanese currency). spending money they don’t have to buy things they don’t need.large capital flows made possible by the integration of financial markets were diverted towards real estate markets in several countries.Second. people living beyond their means. in one word. Much of the economic expansion of the last twenty years has been driven by debt – namely. reduced imported inflation and allowed an easier stance of monetary policy. implied the spilloverof global liquidity in European financial markets. notably those that saw rapid increases in per capitaincome from comparatively low initial levels. But. (4) Third. there is some good news: the long term changes and gains brought about by this recession are going to be phenomenal. . so-called "carry trades" whereby investorsborrow incurrencies with low interest rates and invest in higher yielding currencies while mostly disregarding exchange rate risk. Americans actually spent more money than what they earned. Long Term Gain? this recession – yes.

(Keep in mind GDP could still go up or down based on other non-consumption factors such as manufacturing. any drawback in spending will cause a sizable dent in our economic growth. For example. Nearly three-quarters of the American Gross Domestic Product (GDP) is comprised of consumer spending. which is courtesy of the United States Department of Commerce.Take a look at the following chart. and shows the dramatic decrease in the rate at which Americans have been saving their money: This recession is going to change all of that.33 percent pull back in consumer spending. Therefore.) Consequences (mean effect) 1)Impact on actual & potential growth. there should be a 1 percent decrease in GDP. 2)gdp growth 3) job opportunity 4) Economiy activity . for every 1. which is both good and bad news.

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