Understanding the Great Recession

The Great Recession that began in late 2007 was the worst recession in the post-war era. A significant contributing factor was rapid innovation in the finance industry, which lead to expectations that could not be fulfilled.

McMaster Researcher

Citation

Gunn, C. M., & Johri, A. (2013). An expectations-driven interpretation of the “Great Recession”. Journal of Monetary Economics, 60(4), 391-407.

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What is this research about?

Most economic models that attempt to explain the recession pay little attention to the events that occurred in the years leading up to the recession. This research uniquely examines the effects of the rapid changes in the financial sector how these may have contributed to the onset of the Great Recession. 

What did the researchers do?

The researchers constructed a mathematical model to examine whether over-optimistic expectations, related to new financial innovations, may have contributed to the boom in economic activity shortly before the recession and the ultimate bust resulting in the recession.

What did the researchers find?

The mathematical model developed by the researchers demonstrates that an expectations-driven increase in production and credit can be followed by an economic downturn when those expectations turn out to be false. The over-optimistic expectations of efficiency arose from the rapid innovation that was taking place in the financial sector. The initial response to these expectations is an overall increase in economic activity.  However, once news arrives that these expectations cannot be met then a bust in economic activity soon follows and this could have made a significant contribution to the onset of the Great Recession.

How can you use this research?

This research can be used by financial institutions, such as banks, to understand how different financial practices can affect the economic landscape. In addition, policymakers can use this research to gain a better understanding of what lead to the Great Recession. 

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