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Unformatted text preview: The Global Financial Crisis of 2007–20?? Charles I. Jones * A Supplement to Macroeconomics (W.W. Norton, 2008) March 12, 2009 Abstract This note provides a macroeconomic analysis of the global financial crisis that began in 2007 and continues to this day. What caused the crisis, where does the economy currently stand, and what are the prospects going forward? One way to view recent events is as a balance sheet crisis, both among financial institutions and households. The associated recession is already long and deep. And while the economy will surely recover at some point, the prospects for a recovery in the near term do not look good. This note reviews key macroeconomic facts, provides an introduction to balance sheets and various financial concepts, and studies the financial crisis through the lens of some standard macroeconomic models. * Graduate School of Business, Stanford University. Preliminary — comments welcome. I am grateful to Jules van Binsbergen, Pierre-Olivier Gourinchas, Pete Klenow, James Kwak, Jack Repcheck, and David Romer for helpful suggestions. 2 CHARLES I. JONES 1. Introduction The world economy is currently beset by more macroeconomic uncertainty than at any time in the last 25 years. The financial crisis that started in the summer of 2007 and intensified in September 2008 has remade Wall Street. Financial giants such as Bear- Stearns, Lehman Brothers, Merrill-Lynch, AIG, Fannie Mae, Freddie Mac, and Citigroup have either disappeared or been rescued through large government bailouts. Goldman- Sachs and Morgan-Stanley converted to bank holding companies in late September, perhaps marking the end of investment banking in the United States. While the U.S. economy initially appeared surprisingly resilient to the financial cri- sis, that is clearly no longer the case. The crisis that began on Wall Street has migrated to Main Street. The National Bureau of Economic Research, the semi-official organiza- tion that dates recessions, determined that a recession began in December 2007. By the start of 2009, the unemployment rate had risen to 7.6%, up from its low before the cur- rent recession started of 4.4%. Forecasters expect this rate to rise to 9% or even higher by 2010, and it seems likely that this will go down in history as the worst recession since the Great Depression of the 1930s. This chapter provides an overview of these events and places them in their macroe- conomic context. How did we get here, what are policymakers doing, and, most specu- latively, where is the economy headed? We begin by documenting the macroeconomic shocks that have hit the economy in recent years. Next, we consider data on macroe- conomic outcomes like inflation, unemployment, and GDP to document the perfor- mance of the economy to date....
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