recession

Examples of recession in the following topics:

• Time Lags and Targets

  • The government requires nine months to know whether the economy has entered a recession because economists define a recession as two consecutive quarters of negative real GDP growth.
  • Thus, a government knows the economy is in a recession by the end of the third quarter.
  • For example, the economy entered a recession that lasted only one year.
  • On the other hand, as an economy enters a recession, then interest rates fall.
  • For instance, Japan entered a perpetual recession, starting in the 1990s.

• Term Structure of Interest Rates

  • Yield curve for years 2000 and 2006 predicted the recessions in 2001 and 2007.
  • Yield curve inverted before the recessions of 2007, 2000, 1991, and 1981 had started.
  • Subsequently, the U.S. economy entered the Great Recession in December 2007, becoming the worst recession since the 1930s Great Depression (Haubrich andMillington 2014).
  • Unfortunately, the world's economy still feels the lingering effects of the Great Recession in 2014.
  • It predicted two recessions in 1966 and 1998 that never occurred (Haubrich and Millington 2014).

• Interest Rates and the Business Cycle

  • Empirical evidence indicates that market interest rates rise during a business cycle and fall during recessions.
  • Unfortunately, we cannot prove interest rates rise during economic expansions and fall during recessions.

• Disinflation

  • Disinflation takes place only when an economy is suffering from recession.
  • The causes of disinflation are either a decrease in the growth rate of the money supply, or a business cycle contraction (recession).
  • During a recession, competition among businesses for customers becomes more intense, and so retailers are no longer able to pass on higher prices to their customers.

• Corporate Fraud

  • Enron's managers invested Enron stock in the SPEs.As Enron's stock price soared, the SPE's finances remained healthy until Enron's stock price peaked at $90 per share.Once Enron's stock price began plummeting until it fell below one dollar per share in 2000, the SPEs earned substantial losses.Enron hid the losses and asked banks for more loans that would keep the company afloat, but Enron failed to obtain new loans.The U.S. economy entered a recession in 2001 after many internet companies bankrupted in 2000.A recession always exposes anorganization's weakness.Unfortunately, Enron employees' pension funds were invested in Enron stock, and many employees lost their pension funds and became unemployed.
  • The U.S. economy rebounded from the strong, overly optimistic real estate market.Everyone forgot Enron's misdeeds until the 2007 Great Recession, when the scale of fraud became much larger.For example, Lehman Brothers used exotic securities such as credit default swaps and collateralized debt obligations to buy real estate (Discussed in Chapter 18).After the recession had struck, unemployment doubled, and many households started defaulting on theirmortgages.Commercial and investment banks stopped lending overnight, and real estate prices began tumbling.Unfortunately, Lehman Brothers went on a spending spree, buying real estate toward the peak of the housing bubble.It held $768 billion in bank and bond debt while it had $639 billion in assets that dropped rapidly as real estate prices fell.Lehman Brothers filed for bankruptcy in 2008 and had closed its doors after 158 years of business.

• Government Financial Institutions

  • Some people question a government's role in financing.When a government directly lends, the government squeezes the financial institutions out of the loan market.Furthermore, the federal government loan guarantees increase the problem of moral hazard.Financial institutions receiving the loan guarantees might not screen borrowers as much, lending to borrowers with a high default risk.For example, the effects of the 2007 Great Recession continue to linger in the U.S. economy, even in 2014.Recession caused mass layoffs and doubled the unemployment rate.Then the housing values continue to plummet while foreclosures continue soaring.Consequently, the U.S. government might be liable for trillions of dollars in loan guarantees and bailout of public corporations.We explain several examples below:

• Default Risk and Bond Price

  • Economists use three theories to explain the characteristics of the yield curve and utilize the yield curve to predict recessions.
  • During recessions, when some businesses bankrupt, the default risk increases, increasing the risk premium.

• Chapter Questions

  • How would the demand and supply functions for a bond market shift during a business cycle and during a recession?

• Using the Yield Curve to Estimate Interest Rates in the Future

  • Typically, the Federal Reserve has to cut interest rates during a recession.
  • An inverted yield curve indicates that the economy is in, or is headed for, a recession.
  • This type of steep yield curve can be seen at the beginning of an economic expansion (or after the end of a recession).

• Regulatory Oversight

  • Toxic loans became the first loans to sour as the world's economy entered the 2007 Great Recession.
  • Although the Great Recession had ended in 2009, many developed countries are on the verge of entering a new recession in 2014.