Differences Between 2000s Recession and Great Depression - Example

IB Economics Extended Essay DIFFERENCES BETWEEN 2000’s RECESSION AND GREAT DEPRESSION Ghifari Azka Rassat Globaljaya International School 26th, February, 2012 Introduction The global recession that occurred in late 2000’s and the great depression, affected many country’s economy from around the world. Recession is characterized by low economic activities and growth. When experiencing a recession, the economy of a particular country will have multiple falling macroeconomic indicators such as the GDP, employment, investment spending, capacity utilization, household income, and business profits. On the other hand, bankruptcies and unemployment rate will rise in that particular country’s economy. The important factors for addressing such economic issues include government decisions and interventions, as well as implementation of economic policies, which might help to alleviate economic situations of this kind. To answer my research question “How does the late 2000’s recession differ from the great depression?” I first conducted extensive research on different causes of both events and different economic theories that are relevant to both these events. I also investigated the theory of the GDP, and different monetary policies, which play a big part in both events. An interview with a representative from ‘Moody’s,’ which is a bond credit rating business, took place and gave clear overview of what happened in the late 2000’s recession, offering important insights into the different bonds, which various government entities issued, as well as various commercial agencies. Comparisons between the great depression, which occurred in 1930, and the late 2000’s recession will then be done using relevant information found from the research and from the interview. Economic Theories Gross Domestic Product (GDP) This is the value of goods and services produced in a country at a specific period. This is measured in terms of money (International Labour Organization 1982). If the GDP of a country is growing, it means that the country has a good economy and that the country is moving forward. If a country has a falling GDP it means the country’s economy is in trouble and that the country is moving backwards economically. There are three main ways of determining a country’s GDP. These include production approach, income approach, and the expenditure approach. These approaches measure in detail, the production, income, and expenditure of the country and therefore will indicate the economic performance of a country. Unemployment According to International Labour Organization (1982), unemployment happens when people in a country are jobless yet searching for jobs. The rate of unemployment shows how prevalent unemployment is, and is measured in percentage form. Its calculation formula is: Number of unemployed individuals ÷all individuals in the labor force If a country has a high unemployment rate it means that there are too many of their people who are not working and therefore, cannot maximize the use of resources. If employment rate of a country is high, this means the output in the country will also be high. Similarly, when a country is able to maximize the use of labor force and maximize output, its economy would be in a better state. Inflation This is the increase in the cost of goods and services in a country, over a period of time (International Labour Organization 1982). Each unit of currency is worth less when inflation occurs because with the same amount of money, it is able to buy fewer goods and services. In a country with a relatively high inflation rate, businesses will find it hard to predict the future and accurately calculate prices and returns from investments caused by the wide instabilities of the inflation rate. Businesses will lose confidence in investments and therefore the economy of the country will have a lack of investments. Consumer behavior changes when inflation is high. People tend to buy necessities in advance as much as possible due to their fear of increasing prices from inflation. This could disrupt the market creating redundant shortages (International Labour Organization 1982). Bankruptcy When an individual or a business is not in a position to settle their debts, these will be pronounced bankrupt, following a legal process. Recession is the main reason for many of both personal bankruptcy, and corporation bankruptcy. Capacity Utilization Rate This is a measure of the extent at which output is utilized or met in a country. This determines the general slack present in a company or a country at a specific time. In a recession, the capacity utilization rate will fall due to the lack of demand since during a recession period, people are not confident to spend or invest because they do not know how this state of the economy will take. The Late 2000’s Recession The 2008-2012 global recessions, otherwise referred to as the late 2000’s recession is a global economic decline that started out in December of 2007 and began a significant slump in the September of 2008. This recession influenced the global economy. What stipulates the world economies with continuous problem are the European dominant debt crisis, complemented by the slowing down of the Chinese and the US economic growth. This recession is responsible for the decline in international trade today, the increased unemployment rate, as well as the declining commodity prices. Most economists had made a prediction that the world would experience a recession after the year 2011, which would be worse than the great depression of the 1930’s. Nobel Memorial Prize in Economics winner, Paul Krugman once stated that this recession apparently is the start of a second Great Depression (Krugman 2009). According to Wearden (2008) and Edmund (2008), the situations leading up to the crisis, portrayed by an increase in asset prices and related boom in economic demand, are proved to emerge as the result of the easily available credit, and also the insufficient rule and supervision. Commodity Boom In 2000’s, the world economy experienced a major increase in prices, more importantly in commodities, and in housing. In the year 2008, the price of many commodities, especially food and oil rose sharply. This created an economic harm, threatening stagflation (persistent inflation combined with stagnant consumer demand and relatively high unemployment.) and a turnaround in globalization (Rubin 2008). Figure 1: Brent barrel petroleum spot prices since May 1987 Source: http://en.wikipedia.org/w/index.php?title=File:Brent_Spot_monthly.svg&page=1 For the first time ever, the price of a barrel of oil was sold for more than $100 in early 2008. In the middle of the same year, these prices shoot up to $147.30. On the other hand, a gallon of gasoline cost more than $4 in most areas of the US. This increase in price resulted in low demand, making the prices to be lowered down to less than $35 for a barrel. The prices kept on rising exponentially until the end of 2008, when these significantly decreased, because of the drop in demand (Tradingcharts.com 2004). Housing Bubble As of the year 2007, real estate bubbles was still in progress, especially in USA, UK, UAE, Italy, Australia, New Zealand, Ireland, Spain, France, Poland, South Africa, Israel, Greece, Bulgaria, Croatia, Norway, Singapore, South Korea, Sweden, Finland, Argentina, Baltic States, India, Romania, Russia, Ukraine, and China. This is a run-up in housing prices fueled by demand, speculation, and the belief that recent history is an infallible forecast of the future. In the UK, house prices have been gradually increasing over time, especially in the early 2000s. It is until the late 2000s when house prices finally dropped. Housing bubbles are caused by too much home ownership, low interest rates, and also bad lending practices. Figure2: The UK house prices between the years 1975 and 2010. Source: http://en.wikipedia.org/w/index.php?title=File:UK_real_house_prices_1975-2010.svg&page=1 Inflation In early February 2008, reports suggested that global inflation was at a level that it had never been before. Many nations even achieved their highest domestic inflation rate in 10-20 years. A surplus supply of money around the world, predictions in commodities, agricultural failure, rising costs of Chinese imports, and rising demand for food and commodities have been identified as possible causes for the inflation (Kumar 2008). In the middle of the year 2007, the International Monetary Fund (IMF) data implied that inflation rates were highest in oil exporting countries. Since most countries lack monetary policies, they were not in position to maintain any policy target. The rate of inflation was also observed to increase in the countries that do not export oil, and in the developing Asia regions. The major reason behind this was the high prices of oil and food. Even though inflation was also rising in developed countries, it still remained low compared to the developing world (Kumar 2008). Causes of the Late 2000s Recession The late 200s recession was highly influenced by the large size of debt. In order to address the stock market failure of the year 200, the Federal Reserve thought that making credit easily available would be the best strategy in that issue. However, this dropped the interest rates to a very low level. From these low interest rates, debts were growing at every level of the economy. Private debts to buy more expensive houses were the one causing the most problem. Nonetheless, the high level of debt has been long known as a reason behind recession. Failure of banks and investors to miscalculate and misinterpret the risk level of debts and credit swaps was another reason behind the recession. From this principle, investors and banks structured the risk by taking advantage of low interest rates to borrow huge amount of money, which they could only pay back if the house market’s value kept on increasing. Figure 3: Public Debt as a percentage: Source: http://en.wikipedia.org/wiki/File:Public_debt_percent_gdp_world_map_(2007).svg Additionally, according to most economists, the price of oil contributed to the recession of 2000s. Different researches have shown that if oil prices did not increase between the years 2007 and 2008, then the USA would not have experienced recession in the years, 2007 and 2008 (Hamilton 2009). Effects of the Late 2000s Recession The International Labour Organization (ILO) made a prediction that in 2009, after the recession, approximately 20 million jobs would be lost in different commercial and financial entities. This event will push unemployment up to 200 million for the first time in history. The unemployment could further increase by 50 million if the global recession strengthens (Hamilton 2009). Figure 4: International trade 2009-2010 Source: http://en.wikipedia.org/wiki/File:World_trade_2000-2010.png According to Jones (2008), the credit crunch was responsible for the 50 percent drop in shipping volume in October 2008. This happened just within a week, since the exporters would not obtain letters of credit, owing to the recession (Jones 2008). In the Economist (Feb, 2009), it is noted that the financial crisis led to the emergence of a crisis in the manufacturing sector, affecting the production of industries, thus injuring those economies that relied on industrial exports . Analysts today suggest that the world is experiencing de-globalization and protectionism due to the decreasing percentage of output from different countries around the world. The Great Depression This economic depression happened in the period before the World War 11. Even though different countries have different times of the start of the depression, the most common starting period was in 1930 and lasted until the mid 1940s. Duhigg (2008) notes that, of all the economic slowdowns in the 20th Century, this was the longest and the most devastating. Today, this scenario is given as an example of how the decline of an economy can occur. This depression had America as its starting point, before spreading to other world regions. When the stock market crushed in October 29 1929 (black Tuesday), this economic depression became a worldwide situation. Various cities from around the world were affected badly, especially countries that relied deeply on heavy industry. In many countries, construction stopped momentarily. Prices of crops fall by up to 60% therefore hurting farms and countryside areas. The decline in the economy of the US was what dragged other countries initially. The stock market experienced growth in the late 1929 and early 1930s but this later decreased by April, plunging the world into the great depression, as the levels dropped below 30 percent (Gold Eagle 2008). Figure 5: Wall Street crash on the Dow Jones Industrial Average, 1929. Source: http://en.wikipedia.org/w/index.php?title=File:1929_wall_street_crash_graph.svg&page=1 Causes of the Great Depression During the great depression, America witnessed the highest levels of GDP debts, hitting 300 percent. There were also increased house bubbles in the country, especially in the region of Florida. During the 1920s decade, housing construction surpassed the growth of population by 25 percent (Hansen 1939). Irving Fisher, an American Economist listed nine factors, which creates the mechanics of boom to bust. These were debt liquidation and distress selling, contraction of the money supply as bank loans are paid off, a fall in the level of asset prices, a still greater fall in the net worth of business, precipitating bankruptcies, and a fall in profits. In addition, a reduction in output, in trade and in employment, pessimism and loss of confidence, hoarding of money, and a fall in nominal interest rates and a rise in deflation adjusted interest rates (Irving 1933). At the end of the war in 1918, the European countries, who were allies of America, had borrowed a large sum of money from the banks in America. They were too large that they were not able to repay from their damaged assets. The low population during this period also contributed to the great depression. Evidence shows that during the 1920s, the population was not stable, with decreases in the growth rate. Clarence Barber, an economist at the University of Manitoba stated that the decline in the natural rate of growth might have resulted in a serious depression. This was influenced by the decrease in population growth rate, which in return influenced housing demands (Clarence 1978). Effects of the Great Depression Different countries from around the world suffered different effects from the great depression. A majority of countries created programs for relief and some experienced political turmoil. The UK was hardest hit by increased rates of unemployment. The industrial areas of Britain were affected straightaway as the demand for traditional industrial products malformed. The rate of unemployment rose from 1 million to 2.5 million, by the end of the 1930s. Additionally, the value of exports dropped by 50 percent. In some parts of Britain shipbuilding decreased by 90 percent, making unemployment rate to hit 70 percent (Thegreatdepression.co.uk). In the USA, the president at the time, Herbert Hoover, failed to reverse the recession with various programs he started. They created a tariff, which increased the cost of imported products in order for American products to get more purchase so that it will raise the government’s revenue and help local farmers. Due to the high level of homelessness among Americans, Hoover allowed for the Federal Home Loan Bank Act, as well as construction of homes for homeless people to reduce homelessness, as well as foreclosures (Learn NC n.d). On the other hand, Chile also suffered because of the great depression, more than the UK and the USA. Since the country solely relied on its Copper and Nitrates exports, when the great depression occurred, the demand for these was low. This resulted in a great decrease in government revenue, since these exports accounted for 80% of their government revenue (Learn NC n.d). Conclusion Different scholars of economics have made different comparisons between the two devastating events. Both events are still important in the contemporary world, as countries obtain lessons about the economy. The difference clearly shows that between 1929 and 2008 the world experienced economic philosophy and policy changes. Different from the Great Depression, the Late 2000s Recession was harmonized by the worldwide incorporation of markets. What really hit the late 2000s recession were the housing bubbles and the debt caused by the over lending of loans. On the other hand, the1920s decline in population growth rate affected various aspects of the economy, resulting in the Great Depression. Effect wise, the late 2000s recession saw decreased industrial production levels and a rise in unemployment. In the Great Depression, the main concern and effect was about the local products and the homeless status of many people. Works Cited The Economist 2009, The collapse of manufacturing, Viewed 26 February 2013 < http://www.economist.com/node/13144864> Thegreatdepression.co.uk n.d, Unemployment During The Great Depression. Viewed 26 February 2013 Tradingcharts.com. Viewed 26 February 2013 . Clarence B., L. 1978, “On the Origins of the Great Depression,” Southern Economic Journal, 44(3), pp. 432-456. Duhigg, C 2008, “Depression, You Say? Check Those Safety Nets”, New York Times, Viewed 26 February 2013, Edmund, A October 23, 2008, “Greenspan Concedes Error on Regulation.” New York Times. Gold Eagle 2008, “1998/99 Prognosis Based Upon 1929 Market Autopsy.” Viewed 26 February 2013 < http://www.goldeagle.com/editorials_98/vronsky060698.html > Hamilton, J. D June 16 2008, “Oil prices and the economic recession of 2007-08.” Voxeu.org. Viewed 26 February 2013, Hansen, A 1939, “Economic Progress and Declining Population Growth.” American Economic Review. Irving, F 1933, "The Debt-Deflation Theory of Great Depressions." Econometrica (The Econometric Society) 1 (4): 337–357. Jones, S 2008, “A juddering halt to world trade.” Ftalphaville.ft.com. Krugman, P 2009, “Fighting Off Depression.” The New York Times. Viewed 26 February 2013 Kumar, N July 8, 2008, “Are emerging economies causing inflation?” Economic Times. Viewed 26 February 2013 Learn NC n.d, Herbert Hoover and the Great Depression, Viewed 26 February 2013, Rubin, J 2008, “The New Inflation.” CIBC World Markets (STRATEGECON), Viewed 26 February 2013, Wearden, G 2008, “Oil prices: George Soros warns that speculators could trigger stock market crash.” The Guardian. Viewed 26 February 2013 Read More