The 2008 Crisis and its Relevance Today
The Start of the Financial Crisis
The 2008 financial crisis started when housing prices started decreasing and the housing bubble burst. A bubble occurs when there is an unjustified and collective belief that prices will rise, resulting in broad-based demand for that asset and consequently rising prices.
The Road to Recovery
The financial crisis hit the economy mainly through the financial panic and credit crunch channels. In other words, runs and relayed events disrupted the financial intermediation and limited the willingness of banks and investment banks to supply credit. The government took many measures to address this channel through which the financial crisis affected the economy. First, the Federal Reserve opened many liquidity facilities to ensure that banks would still provide credit and avoid further fire sales. In addition, to calm money market mutual funds the government provided them deposit insurance. Furthermore, the government introduced stress tests and, although most investment banks failed them, it calmed markets since it was a first attempt to measure the risk in the market. Lastly, the government introduced several rounds of quantitative easing (QE) and forward guidance. During the crisis the nominal interest rate hit the zero lower bound and the Federal Reserve used quantitative easing (asset purchases by central banks) and forward guidance (communications about monetary policy of the future) to lower the interest rate more and stimulate the economy.