A. Throughout American history there have been periods of financial boom and bust, economic growth and recession. The most recent recession from the third quarter 2007 to the second quarter 2009 seemed like an extraordinary period of recession. The S&P 500 shrank from about 1300 points to 666 points (50%), evaporating capital in a matter of days. However, this recessionary period was quickly turned around to economic growth again.
The average post-World War II length of economic contraction has been 11.1 months, whereas the 2007 recession had a 1.62 times longer contraction period: 18 months. Similarly, expansion periods have lasted 58.4 months post-WWII, compared to the 2008 expansionary period that lasted a whopping 73 months; this
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However, the housing market collapse was a main driver for thrusting the U.S. economy into recession. Starting in the early 2000s and becoming more frequent in 2005 and 2006, lenders were giving out “subprime mortgages.” Subprime mortgage are residential and commercial loans given to under-qualified and financially unsound borrowers. Housing prices were expected to continue rising 20% every year, so banks could lend based on that factor alone; default was essentially protected by the expected increase in property value since the date of lending. However, lending rates began increasing and people became unable to repay their loans and defaulted on mortgages. Banks tightened lending and made credit less available to investors to protect themselves.
The widespread loan default created gaps in lending banks’ books. Financial institutions that were investing in mortgage-backed securities started experiencing big losses. The Federal Reserve was forced to lower the Fed funds rate, effectively increasing savings and decreasing consumption. Wealth decreased, partially from the stock market plunge and partially from the decrease in value of one of the biggest sectors of the United States GDP.
D. According to the Goods Market Model, a decrease in wealth effectively increases savings and decreases current consumption. Taking consumption smoothing into account, future consumption is also decreased. In order to keep price stability