Global Recessions

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Date: 2016
Publisher: Gale, a Cengage Company
Document Type: Event overview
Length: 1,581 words
Content Level: (Level 4)
Lexile Measure: 1170L

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A global recession is a worldwide economic slowdown, one that may begin in one country but that eventually spreads to affect nearly every country on earth. In global recessions, stock markets, personal wealth, and banking industries are dramatically hurt. Businesses cut staff, unemployment rises, and people can remain out of work for years. The financial crisis of 2007 and 2008 was a notable example of a global recession, as nearly the entire world felt the ripple effects of collapsing markets and failing banks. This crisis was one of the largest causes of the ongoing Eurozone debt crisis, which has seen several European countries, notably Greece, fall into bankruptcy and high unemployment. In 2015, after defaulting on a loan repayment to the International Monetary Fund, Greece agreed to a new deal to secure bailout funds from the European Union. These steps were meant to help Greece escape the effects of the global recession that had been affecting it for years.

What Is a Recession?

Recessions are generally defined by the US government as two or more quarters of a declining gross domestic product (GDP), the total market value of all goods and services produced in a given period. The National Bureau of Economic Research determined the US economy entered a recession on December 1, 2007, and the recession ended in June of 2009. This end to the recession did not mean that the economy had recovered, however, and the effects of the US recession were felt globally.

Who Was Affected?

The US economic downturn affected many countries, among them Italy, Spain, Greece, and the United Kingdom. Much discussion of the global economic crisis has centered on the Eurozone, those European countries that share a common currency and trade agreements.

What Caused the Recession?

The United States

In the United States and elsewhere, housing prices rose rapidly. Though many experts warned homes were overvalued, prices continued to rise to record levels. This housing bubble enabled people to borrow against the value of their homes, increasing personal debt. Some experts said people treated their homes “like ATMs.” A 2001 recession in the United States slowed wages and increased credit card debt. By 2006, the housing market had started to collapse, with home prices and home sales falling. Home buyers began defaulting on their mortgages, and banks foreclosed on properties.

Many significant factors converged in 2008. The investment bank Bear Stearns fell in March. Treasury secretary Henry Paulson stepped in and orchestrated the sale of Bear Stearns to JPMorgan Chase. In September, Paulson nationalized mortgage finance giants Fannie Mae and Freddie Mac. A week later Lehman Brothers, the fourth-largest Wall Street investment bank, declared bankruptcy.

The collapses of these financial institutions and others were related to the housing bubble. Many investment banks sold securities based on US mortgages to investors around the world. They ignored information that mortgage brokers were giving loans to people who could not repay them. When the housing bubble burst, real estate prices plummeted, as did the values of the securities. Lehman Brothers and other banks also heavily financed commercial properties. In addition, Lehman Brothers carried a lot of debt, holding less than $1 in reserves for each $30 of liabilities; the value of its assets was questionable.

When the US government decided to act, the Department of the Treasury convened bankers to find a way to rescue Lehman Brothers. No private-sector salvage was to be had. The bank’s collapse reverberated through the stock market. The insurance giant American International Group (AIG), with its subprime mortgage trades, was in danger and was nationalized. Paulson and Federal Reserve chairman Ben Bernanke met with legislators in Washington, DC, painting a picture of complete financial collapse of the banking industry and even martial law. Eventually the US Congress voted for a Wall Street bailout to halt the financial hemorrhaging. The formerly unimaginable failure of Lehman Brothers had shocked the financial system and triggered the global recession within weeks.

Many experts blame the 1999 repeal of the Glass-Steagall Act of 1933 for the crisis. The legislation, instituted after the 1929 Wall Street crash, kept commercial banks from merging with investment banks. This kept depositors’ money safely out of the hands of investors.

The Eurozone

While the US housing-bubble burst and subsequent devaluation of securities based on mortgages contributed to other countries’ economic woes, their financial difficulties are rooted in earlier developments as well. During the 1990s, when the European Union (EU) was being set up with the euro as currency, the governments agreed to rules limiting borrowing each year to 3 percent of their economies’ output. These rules were meant to prevent countries from accumulating too much debt. Some countries, however, failed to follow the rules.

Germany and Italy were the first large countries to break the rule about the borrowing limit, followed soon by France. Spain held to the 3 percent rule until 2008, when the financial crisis took place. When southern European countries joined the EU, interest rates fell, encouraging private borrowing, including mortgages. The German economy flourished as the country exported goods, and the surplus was loaned to southern Europe. Wages rose in these countries, while German wages remained steady. The loss of competitiveness further reduced exports to Germany.

Greece joined the EU in January of 2001. EU countries use a common currency, the euro, which simplifies trade. Some EU members were concerned about linking their economies with that of a weaker nation; inflation was a particular concern. Greece never followed the 3 percent rule. In 2004, Greece admitted some of its data was not correct, and its economic situation was weaker than reported in seeking EU membership. The Greek government implemented austerity measures to slash the deficit and raised taxes on alcohol and tobacco. The economy seemed to improve; then the government faced mounting debt. Greece’s credit rating was downgraded, and shares fell around the world in 2009. Even more austerity measures were implemented, and the government sought loans from the International Monetary Fund (IMF), receiving billions in a rescue package. Protesters violently denounced the austerity measures, and in mid-2011 Greece sought more loans. In October of 2011, European leaders agreed to reduce Greece’s debt by half; the following month, EU leaders admitted Greece might have had to leave the EU to save the single-currency system.

Many European countries were struggling. Italy’s borrowing costs on debt rose in late 2011 to their highest level since the euro was founded. Though the government also announced it would reduce the budget deficit, weeks passed and the plans were not implemented. Britain, as a member of the IMF, was expected to help support the global economy. Some experts believe Britain slid into a recession at the end of 2011. Ireland cut spending and appeared to rebound, only to see its economy worsen in 2010. The same thing happened in 2011.

Spain, too, slashed its budget and froze wages, as unemployment remained high and the country extended benefits to those unable to find work. Civil servants had their work weeks extended to 37.5 hours from 35, and vacancies in many departments remained unfilled. There also were plans in 2011 to raise income taxes and property taxes. Spain had earlier tried to reform its employment system, but was thwarted by trade unions and settled for a two-tier system. Many established employees were virtually guaranteed jobs, while the larger pool of workers toiled with no job security. In late 2011 Spain’s unemployment rate was 23 percent.

After the Global Recession

One strategy for governments to recover from recession is to cut spending. Unemployment would likely remain high, which could lower wages, making them more competitive. Lower wages could also reduce spending as people have trouble paying their debts. Some experts say not cutting spending could lead to more borrowing—if other governments are willing to help—and possible economic collapse.

Some US experts cite the recession that followed 1937 austerity measures implemented by President Franklin D. Roosevelt as proof that a poor economy is no time to balance the budget. The economy had been steadily improving from the Great Depression until the government began slashing spending. This theory was first proposed by British economist John Maynard Keynes, who said, “The boom, not the slump, is the right time for austerity at the Treasury.” Many legislators, however, believe reducing debt through austerity programs is the best way to stimulate the economy.

By late 2015, Italy had instituted economic reforms and tax cuts meant to redirect the country’s previously suffering economy. At that time, the government claimed Italy would not be affected by the global economy for another year to two years, due to these insulating reforms. Some economists claimed, however, that the recent slowdown of Chinese markets would soon strike Europe and, indeed, Italy. Though the Italian economy was not in freefall as it once was, it continued to stagnate, keeping unemployment high. The central government, however, maintained that its reforms would help begin the slow path to recovery.

Greece, meanwhile, was experiencing similar economic anguish. In June of 2015, it defaulted on a $1.7 billion loan repayment to the International Monetary Fund (IMF). The country was bankrupt, and only hours before it formally defaulted, it requested €29 billion of bailout money from the European Union. These creditors ultimately agreed to loan Greece new funds and keep it from exiting the European Union if it could meet certain economic standards. In November of 2015, Greece reached an agreement with Europe to secure the first bailout transfer of €86 billion. Skepticism continued to surround the Greek economy, however, leaving some to believe Greece would not soon emerge from its recession woes.

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Gale Document Number: GALE|EJ2181500248