One - The 2008–2009 Recession

Summary

After the end of the Volcker disinflation in 1983 and through the end of 2007, growth in the world economy proceeded steadily, interrupted only by two minor recessions starting in 1990 and in 2001. Economists talked about the Great Moderation. The Great Recession, which began in the United States in December 2007, came as a shock. Once again, economists and the public began to ask fundamental questions about the nature of free-market economies. Are they inherently unstable? What kind of government policy can stabilize economic fluctuations?

This chapter reviews what is at stake in understanding the cause of the 2008–2009 recession. Seemingly commonsensical but misguided responses to the distress suffered during recession not only can be ineffective, but also can harm long-term growth. Such responses can also direct public policy away from the institutional arrangements and policies required to prevent cyclical instability. The following chapters contrast two explanations of the business cycle. One explanation highlights market disorder resulting from swings in the psychology of financial markets from excessive risk taking to excessive risk aversion. The other explanation highlights monetary disorder based on central bank (Federal Reserve) interference with the operation of the price system.