What Caused the Great

Recession?
Eric Tymoigne
Lewis and Clark College, Economics
March 2014
2008: "Why did nobody notice it?"
Consensus: Nobody Saw It Coming
Robert Rubin: "few, if any people anticipated the sort
of meltdown that we are seeing in the credit markets at
present.
Glenn Stevens, Governor of the Reserve Bank of
Australia: I do not know anyone who predicted this
course of events.
Alan Greenspan: Once-in-a-century credit tsunami

=> The Great Recession was caused by a random, tail-

end, negative shock on the economy; a black swan
event (Nassim Nicholas Taleb).
2012: Perhaps it is difficult to
foresee [a financial crisis].
HmmActually quite a few
economists saw it coming
The problem was that the economic framework used by
most economists was not adequate to deal with
financial issues:
Financial markets are efficient and self-correcting: bad apples
are eliminated through market mechanisms
Money is neutral: does not affect economic outcomes in terms
of employment and economic activity => studying the
financial side of the economy is not relevant to understand
how the economy performs.
Credit risk is not relevant: not included in models except as a
random shock (no financial system in mainstream
macroeconomic models).
HmmActually quite a few
economists saw it coming
Greenspan 2005: development of financial products,
such as asset-backed securities, collateral loan
obligations, and credit default swaps, that facilitate the
dispersion of risk These increasingly complex financial
instruments have contributed to the development of a
far more flexible, efficient, and hence resilient financial
system than the one that existed just a quarter-century
ago
Das 2006: [f]inancial risks, particularly credit risks, are
no longer borne by banks. They are increasingly moved
off balance sheets. Assets are converted into tradable
securities, which in turn eliminates credit risks.
A few who of those who saw it
coming:
Wynne Godley 2000: The U.S. expansion has been driven to an
unusual extent by falling personal saving and rising borrowing by
the private sector. If this process goes into reverse, as has
happened under comparable circumstances in other countries,
there will be a severe recession
Dean Baker 2002: The fact that people are borrowing against their
homes at a rapid rate is more evidence of an unsustainable bubble.
The ratio of mortgage debt to home equity is at record highs.
Some regulators: Brooskley Born (CFTC: resigned in 1999 after
being stripped of her ability to regulate derivatives), Governor
Gramlich (Federal reserve: Ignored by Greenspan in 2000)
See Revere Award for Economists and Got it Right project.
Common theme among of those
who saw it coming

Hyman P. Minsky
Stability is destabilizing
My research: Using Minskys
analytical framework to understand
the

Great Recession
Long periods of economic prosperity lead to the growth of financial fragility
i.e. growing use of debt.
Overtime the debt accumulated becomes unsustainable => financial crisis
The great recession has its root in the 1980s with the growth MONEY
MANAGER CAPITALISM:
Growing role of finance for the determination of economic outcome
Increasing reliance on debt to sustain standard of living
Increasing reliance on financial gains to make a living and guide incentives (online trading, pension
funds, mutual funds, stock-options instead of salaries to reward top managers)
Deregulation of economy and retrenchment of government in economic activity:
finance, labor, health, education => depressed wages, shift of burden on workers,
growing inequalities
Fiscal austerity: promotion of fiscal surplus forced private sector into debt
(accounting: someone must be in deficit if someone else is in surplus).
Develop a measure of financial
fragility
Financial Fragility Index and Heat Map, (1996 = 100)
 Estimating the Cost of a Job Guarantee Program,
Experience from the New Deal Programs
Less 5 to 10 to 15 to 20 or
Unemployment Rate
than 5 9.99 14.99 19.99 more
Earnings to GNP,
0.63 1.86 2.09 1.72
Actual 0.15
Earnings to GNP, FE 0.64 1.81 4.43 7.41 11.25
Earnings to GNP, FE
2.15 5.21 8.91 14.53
+ ELW 0.78
Earnings to GNP, FE
2.81 6.55 11.16 18.09
+ MLW 1.04
Total Cost to GNP,
1.03 2.42 2.64 2.12
Actual 0.34
Total Cost to GNP, FE 0.85 2.41 5.90 9.88 14.99
Estimated Average
Total Cost to GNP, FE of the Cost of JG for Four Different
Scenarios, GNP 2.87
+ ELW Percent of 1.04
6.95 11.88 19.37
Total Cost to GNP, FE
Actual Cost of Work Programs Relative to GNP. All unemployed are enrolled. Paid
3.74 two 8.74
possible14.88
wages 24.12
+ MLW 1.39
Problem: Only 30% of unemployed and not paid
enough to sustained their family