A Story of Two Economic Recessions

As the European Central Bank (ECB) prepares to deliver yet another round of monetary policy easing, it is perhaps a good time to compare the two economic recessions in the last decade or so. Unfortunately for many people, two economic recessions hit the developed world in a little over ten years. 

The two recessions are different. They were caused by different things and, to some extent, even the response for monetary authorities was different.

How do the policymakers decide what is the appropriate response? Comparing the two recessions might offer us the answer.

The 2008 – 2009 Great Financial Crisis

Like the name suggests, the economic recession in 2008-2009 was a financial crisis. The housing prices fell 31.8% due to the collapse of CDOs (Collateral Debt Obligations) – derivative instruments on the financial market.

In response to the rising unemployment and shrinking GDP, the U.S. authorities reacted swiftly. First, the Fed lowered the rates close to the zero level. Second, the federal authorities bailed out AIG (American Insurance Group), in a deal having a price tag of $182 billion. Moreover, around $200 billion moved from money markets to treasury bonds.

The 2020 Coronavirus Crisis

The economic recession created by the coronavirus pandemic differs in terms of its scale. This time, the global economy contracted, not just a few ones.

As such, the response was more aggressive. In the aftermath of the 2008-2009 Great Financial Crisis, the Fed introduced quantitative easing, with the aim of lowering the yields on the yield curve. However, before reaching that target, the yields remained elevated, so that investors turned from money markets to bonds.

Fiscal support also differs in 2020 when compared to ten years ago. This time, governments around the world offered some kind of fiscal assistance to businesses and households.

As the chart above shows, the U.S. 2-year real yield differential when compared to the rest of developed markets dropped dramatically in 2020 when compared to 2008-2009. Also, in the meantime, one of the most important central banks in the world, the ECB, introduced the NIRP (Negative Interest Rates Policy).

In other words, the two economic recessions were too close in time for monetary authorities to normalize the policies. Otherwise, how to explain the fact that the coronavirus pandemic caught the ECB with an active NIRP? Therefore, we may easily say that, at least when it comes to the Euro area, the 2008-2009 economic recession did not end, if only judging by the ECB’s easing measures.