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Paper Example on Great Recession Causes

4 pages
903 words
Carnegie Mellon University
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The 2007 recession was primarily caused by the bubble in the housing industry. The housing bubble started in late 2005 until the beginning of the recession in late 2007. In early 2006, the housing prices went up. The real estate boomed hence resulting in many financial institutions giving mortgages with low rates. It prompted many people to secure the mortgages; most of whom were not able to repay. With increased mortgage default in the months leading to December 2007, many financial institutions began having cash flow crisis. The financial industry had a crash at the start of 2008. It pushed the Mortgages rate up as shown in figure 1. The financial industry crash resulted in the entire stock markets crashes. The same was attributed to the herding behavior of investors and fears of many losing most of their investment. The effects of the recession are seen in the increased unemployment after 2008 and reduced household income (Address: & Number:, 2018).

Figure SEQ Figure \* ARABIC 1: Fixed rate mortgage average from 2007 to 2017

Housing industry indices trends

The housing industry had notable changes within the years 2006 to 2017. The housing industry indices are mainly the mortgage rate and the housing price index. The mortgage rate refers to the rate that the lenders use to calculate annual repayments from the mortgagor. The mortgage rate was low before the recession; meaning housing finance was easy. The trend changed during the recession, and the rates hit peaks of 6% plus. After the recession, the mortgage rates have been declining. The housing price index was high before the recession. From figure 2, the housing price index reduced; showing a decrease in the price of the houses. The price of housing began increasing in 2012 after the recession had already gone down. The cost of financing was influenced by the financial institutions need to fund the mortgages. The finance institutions crash also influenced the prices of housing. The changes in the fiscal and monetary policies have made most of the changes after 2012 to largely depend on the supply and demand and not external events. High mortgage rates and low financing will mean the housing investors will make losses.

Source: ("U.S. Bureau of Labor Statistics", 2018)

Figure SEQ Figure \* ARABIC 2: National home price index from 2007 to 2017

Role of government in causing the recession

Before the recession, particularly in 2001, the Bush government suggested the dollar to be made cheap. The Fed came up with a policy of expanding the money supply in the economy. Concurrently, the housing policies set by the government at that time was a major cause of the subprime mortgage crisis. The government housing policies introduced the subprime lending which was able to give credit to even individuals with high risk of default. The interest given to the high-risk mortgagors was also high which was a cushion for the banks but also increased the certainty for default. The combination of the cheap dollar and the subprime lending and housing was part of the government contribution towards the recession. The two regulations caused the demand bubble. Increased money supply and low-interest rates would typically increase the demand for the population. The demand resulted in the financial bubble. In essence, the economy had not improved in the same margin as the population demand. That can be seen in the employment rate from 2001 to 2006 which were increasing and not decreasing. It is from the two policies that the bubble and crash happened.

Monetary and fiscal policies

The federal government can change the fiscal policies of the country. The fiscal policies include the taxation rules and the government spending. The fiscal policy can thus be expansionary or contractionary. During an economic policy, the federal government may determine whether to apply the expansionary or contractionary policies. Expansionary policy is supposed to increase the supply of the money in the economy and include lowering the taxes and increasing the spending ("Fiscal vs Monetary Policy", 2018). The crisis that is controlled by reducing the money in the economy is then solved by contractionary policies which are increasing the tax and reducing the government spending.

The federal reserve system controls the monetary policy. The main change in the monetary policy is changing the interest rates to control the appetite for debt. Through the changes in the interest rates, the federal reserve system will thus be able to control the aggregate demand. When the interest rates are increased, the money supply decreases in the economy while when the rates are decreased the money supply increases. Ferrara, however, says that the interest rates reduction may not necessarily control a crisis such as a recession (2018). The market may be tight hence the interest rates may not necessarily control the money supply in the economy. The market should, thus, be analyzed to determine whether it may be falling as a result of the interest rates or not.

The federal reserve system has statutory mandates that are expected to shield the economy from adverse effects in case a financial crisis occurs. The statutory mandates are providing maximum employment to the population, keeping stable prices for the goods, and maintaining moderate interest rates.


Address:, M., & Number:, P. (2018). Bureau of Labor Statistics | USAGov. Retrieved 23 January 2018, from

Ferrara, P. (2018). Forbes Welcome. Retrieved 23 January 2018, from

Fiscal vs Monetary Policy. (2018). Retrieved 23 January 2018, from

U.S. Bureau of Labor Statistics. (2018). Retrieved 23 January 2018, from

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