Case Study 1 — The Great Recession (2007–2009): A Financial Crisis Becomes an Economic Crisis
The 2008 Great Recession was the most severe economic downturn since the Great Depression. This case study synthesizes the financial crisis story from earlier chapters (2, 16, 26) with the business-cycle framework.
The sequence
- Housing bubble (2003–2006): low interest rates + loose lending → housing prices doubled
- Subprime defaults (2007): housing prices fell → mortgage defaults rose → MBS lost value
- Financial system froze (2008): Lehman collapsed → short-term funding markets froze → banks stopped lending
- Real economy contracted (2008–2009): credit freeze → businesses couldn't borrow → spending collapsed → layoffs → more spending cuts → deeper contraction
- Slow recovery (2009–2017): damaged financial system + inadequate fiscal stimulus + hysteresis → the slowest postwar recovery
Key numbers
- GDP: −4.3% peak to trough
- Unemployment: 4.4% → 10.0%
- Home prices: −30% nationally
- Stock market: S&P 500 fell 57%
- Recovery to pre-crisis GDP: about 3 years
- Recovery to pre-crisis employment: about 6 years
What made it different
The 2008 recession was a financial crisis recession — caused by the collapse of the financial system, not by a normal demand downturn or a supply shock. Financial crisis recessions are deeper and longer because the damage to the banking system impairs the economy's ability to recover (banks can't lend, firms can't invest, consumers can't borrow).
Discussion questions
- The 2008 recession started with a housing bubble. Could better regulation of mortgage lending have prevented it?
- Was the ARRA stimulus ($800B) too small? What would the counterfactual (no stimulus) have looked like?
- The recovery took 6 years for employment. Apply hysteresis (Chapter 24). Was the slow recovery avoidable?