The Role of Banks in Economic Recessions

Topics: Monetary policy, Inflation, Recession Pages: 5 (1631 words) Published: November 10, 2010
The role of banks in economic recessions

In today’s wavering global economic context, the word `crisis` is omnipresent, taking the media by assault and infringing into the population’s daily life, although many countries haven’t even officially entered recession yet. Although recession is generally referred to as a negative Gross Domestic Product growth for a period of at least two consecutive quarters, other important economic change variables, such as current national unemployment rates, consumer confidence, capacity utilization, spending levels and business profits must be taken into account when defining a recession and its attributes. Therefore, recession can be seen as a general slowdown in economic activity in a country over a sustained period of time, or a business cycle contraction (which normally follows an economic boom). Raging from “The panic of 1797” (the first US recession, caused by the deflating effects of the Bank of England as they crossed the Ocean to American soil), reaching their climax at the beginning of the Great Depression, in the 1920s and 1930s, and continuing with the ongoing financial crisis led worldwide craze (considered to be the most serious crisis since the Great Depression), economic recessions have occurred all throughout the history of modern economics. While many mainstream specialists argue that they are part of the natural cycle of the economic system and must be seen this way, Marxists call it an inevitable part of capitalism. As far as the causes of recessions are concerned, it is believed that they are primarily generated by inadequate aggregate demand in the economy, as a result of the actions taken to control the money supply, combined with external economic shocks and the unwinding of major imbalances in the economy. Over the ages, banks, as major financial institutions, have played an important part in the emergence and evolution of recessions. In the case of the Great Depression, for instance, the tight monetary policies instituted by the Federal Reserve in order to temper the effects caused by the stock market crash, resulted in a currency shortage which led to severe bankruptcies and massive money withdrawal, practically destroying consumers’ confidence in banks. Instead of increasing the money supply, the Federal Reserve allowed it to fall 30%, which resulted in the most severe economic crisis of all times. The global economic recession we are currently going through also has its origins in the US economy and seems to have been caused by the dramatic structural adjustments the US economy is undergoing, an inappropriate monetary policy which helped inject tremendous amounts of money supply into the money market, keeping interest rates lower while inflation continued to rise, combined with relaxed policies in lending practices and an excessive competition in the banking sector that stimulated impressive credit and subprime mortgage expansion worldwide. The premises for this particular recession were formed decades ago, together with the worldwide liberalization of the financial market, which was accompanied by inappropriate public control and regulations and led to government’s control being unable to keep up with the spectacular breakthroughs in the field of financial products and services. The expansion of these financial innovations, accompanied by an extremely low interest rate and an ease on credit policies, resulted in economic bubbles on the real estate market. Therefore, banks giving out credits started selling them to affair banks, such as Lehman Brothers, which resold them in advantageous packages, until track of risk guarantees was lost. This caused an over excessive offer on the real estate market and, consequently, severe losses to those in possession of the mortgages: banks. Thus, a lack of confidence in banks arose among the population, leading to withdrawals and...

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