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

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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.

Fiscal Stimulus in the Pandemic vs the Financial Crisis

The goal of the current fiscal stimulus is to “freeze” the economy and in the future to “unfreeze” it as economic activities resume. In contrast, in 2008 the stimulus was supposed to stimulate the economy and avoid scarring. As opposed to the previous crisis, arguably there is nothing fundamentally wrong with the financial system in the status quo. External factors are the primary cause of the market reaction with the pandemic and health crisis limiting economic activity.

Both the Great Recession and the current crisis have common fiscal policies when it comes to minimizing scarring through unemployment or loss of income as the Fed tries to expand the social safety net. This is done primarily through unemployment benefits and direct payments to households.

One of the bigger differences is the allocation and size of some of the other funds. For example, a significant part of the current 3T fiscal stimulus package (130 billion dollars) went towards the health care system. In addition, a big part of the current package is targeted towards helping small businesses. On the other hand, in 2008 we saw tax incentives rather than loans being offered. Additionally, in 2008 a significant portion of the stimulus went towards helping individuals dealing with mortgages/housing defaults and education, i.e. college debt, which we are not seeing in the current crisis.

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