Crisis preceding the Great Recession

In the past decades, great recessions were very rare until 2008. Comparing the Great Recession to other severe recessions help to grasp the possible consequences for the economy in the long run

The current economic crisis is now often being compared with the economic crisis in Japan after the property and stock bubble burst in the early 1990's and with the Great Depression that had the world in its grip in the 1930's.

• The Great Depression shows the possible consequences of asset prices plunging and a credit bubble bursting at the same time. National income in the US fell by 30% between 1929 and 1933, unemployment rose to 25% and deflation was at 25%. Banks suffered major losses due to risky loans, falling asset prices and the depression. Moreover, consumer confidence in banks collapsed. As a result, more than 10,000 of the almost 25,000 banks went bankrupt and money supply fell by 30%.  Although the Great Depression hit almost every country, the impact in France, Great Britain and Canada was relatively slight in comparison with the US. This is generally attributed to the fact that these countries abandoned the gold standard far earlier and so managed to avoid a bank crisis. This allowed these countries to easily increase the money supply, so the banks could quickly resume credit extension.
• The causes of the Japanese crisis are highly similar to those of the Great Depression. After the property and stock price bubbles burst, Japanese banks found themselves in deep trouble, as the collateral for many loans was property and/or stocks and hardly any buffers had been built up. The difference with the Great Depression, however, was that it was an isolated occurrence. The rest of the world economy continued growing rapidly.

The economic decline in the 1930s was terrible, particularly in the US. According to many economists, the American authorities contributed by keeping monetary policy too tight, for example (to maintain the gold standard) and increasing taxes during the crisis to bring public finances into balance. The government also raised import duty on agricultural goods, initially, but later also on industrial goods. As other countries quickly followed the example, world trade collapsed by two thirds in the space of five years. This was also extremely negative for the world economy.

The implications for the Japanese economy were less than in the Great Depression. Intervention by the central banks and government shored up many bankrupt Japanese banks (also referred to as zombie banks), preventing a real bank crisis. At the same time, the government and the central bank started pumping enormous amounts of money into the economy. This preventing economic decline. Consequentially, however, government debts exploded (public debt rose from 61.4% of the economy in 1991 to 122.1% in 2003) Moreover, the aftermath lasted a long time. After the stock and property bubble burst, the domestic economy struggled.  Long/term deflation inhibited consumption, investment failed to revive and wages dropped. This period is often referred to as Japan´s lost decade. Economists blame this on the Japanese authorities´ slow reaction in easing monetary and fiscal policy, for example. The government should also have immediately taken over the zombie banks, restructured them and sold them on.  Incidentally, in the past few years Japan has experienced the longest period of expansion since World War II. This, however, was due to rapidly growing exports and related investments, not to growth of the domestic economy.