Question

How, in general, can a financial crisis lead to a recession? What, in particular, precipitated the severe recession of 2007-2009? Include in your discussion what role the government, businesses, and consumers played in the economic downturn.

Answer 1

A money crisis will have Associate in Nursing adverse wealth effect; if assets lose price and folks have poor expectations for the economy, defrayment and investment decrease, resulting in recession. recession is outlined as once businesses stop to expand, the value diminishes for 2 consecutive quarters, the speed of state rises and housing costs decline.

Fiscal policy depends on the government’s powers of paying and taxation. each taxation and government defrayment may be accustomed scale back or increase the whole provide of cash within the economy—the total quantity, in alternative words, that companies and shoppers have to be compelled to pay. once the country is in a very Recession, the suitable policy is to extend defrayment, scale back taxes, or both. Such expansionary actions can place more cash within the hands of companies and shoppers, encouraging businesses to expand and shoppers to shop for a lot of merchandise and services. once the economy is experiencing inflation, the alternative policy is adopted: the govt can decrease defrayment or increase taxes, or both. as a result of such contractionary measures scale back defrayment by businesses and shoppers, costs return down and inflation eases.
Now coming back to the most question that "What, especially, precipitated the severe recession of 2007-2009?"

Irrational exuberance within the housing market crystal rectifier many of us to shop for homes they could not afford. everybody thought housing costs might solely go up. several investors took advantage of low rates to shop for homes simply to sell. Others bought homes they could not afford because of interest-only loans then the primary sign that the economy was in bother occurred in 2006. that is once housing costs began to fall. At first, realtors applauded. They thought the hot housing market would come to a a lot of property level.

This caught many householders off guard, UN agency had taken loans with very little cash down. As they completed they'd lose cash by merchandising the house for fewer than their mortgage, they foreclosed. Associate in Nursing escalating proceedings rate panicky several banks and hedge funds. that they had bought mortgage-backed securities on the secondary market and currently were facing Brobdingnagian losses.By August 2007, banks became afraid to lend to every alternative as a result of they did not wish these noxious loans as collateral. This crystal rectifier to the $700 billion bailout, and bankruptcies or government nationalization of Bear Stearns, AIG, Fannie Mae, Federal Home Loan Mortgage Corporation, IndyMac Bank, and Washington Mutual. Banks panicky once they completed they'd have to be compelled to absorb the losses. They stopped loaning to every alternative. They did not wish alternative banks giving them no-count mortgages as collateral. nobody needed to urge stuck holding the bag. As a result, interbank borrowing prices rose. This mistrust at intervals the banking community was the first explanation for the 2008 money crisis,

AFTER THE CRISIS, BANKS REFUSE TO LEND, and also the ECONOMY SHRINKS

Banks lend once they’re assured that they'll be repaid. thus once the economy is doing badly, banks like better to limit their loaning. However, though they scale back the number of recent loans they create, the general public still have to be compelled to continue repayments on the debts they have already got.The problem is that once cash is employed to repay loans, that cash is ‘destroyed’ and disappears from the economy.So once individuals repay loans quicker than banks square measure creating new loans, it’s like exhausting the oil from the engine of a car: the economy slows down and costs decrease. As a result the economy risks slithering into a ‘debt-deflation’ spiral, wherever wages and costs fall however people’s debts don't modification in price, resulting in debts turning into comparatively dearer in ‘real’ terms. Even those businesses and folks that weren’t concerned in making the bubble suffer, inflicting a recession.