Unit 3 Aggregate demand and the multiplier model

3.1 The ‘great recession’: Hardship at home and at work

In 2006, Lisa bought a house in Florida. Things were going well for her family: she and her husband were expecting their second baby; they’d established a successful web design company that brought them a high income. The housing market was booming and large mortgages were easily available, but she wanted to take some time off to care for the children and was careful not to borrow more than they could comfortably afford to repay.

Then came the global financial crisis. It started in 2007 when US house prices began to fall, and spread through financial institutions across the world. The investment bank Lehman Brothers, which collapsed in September 2008, was just one of many bank failures. And the whole global economy was affected: the financial crisis led to a sustained fall in output in many countries, sometimes described as ‘the great recession’. By mid-2009, the gross domestic product (GDP) of the US—that is, its aggregate output—had declined by 4.3%.

Everything began to go wrong for Lisa. Business declined—people were no longer buying bespoke website designs. And as she says, ‘Desperate times can really change people.’ Her husband panicked when he realised the business was in serious trouble; he took all of the family’s money, and disappeared.

Lisa was left with a mortgage and two small children to provide for. The market value of her house was falling rapidly. The business was gone, and her debts were accumulating. She says: ‘I had to learn to be poor again.’ She took on three jobs, and her parents took care of the children while she worked. The recession led to a crime wave in her neighbourhood—the family was robbed repeatedly.

In 2011, Lisa was declared bankrupt. She stopped repaying the mortgage and the bank repossessed her house.

In the succeeding years, Lisa was able to rebuild her life. But the experience left its mark. Reflecting back on it 10 years after the collapse of Lehman Brothers, she says, ‘I feel less safe now than I did before the crisis … Corporate America might get a bailout, but no one was going to bail me out.’

The total output of a country, and the incomes of its residents, fluctuate from month to month. On average they tend to grow. But periodically we experience recessions, when output and incomes fall month after month and sometimes for periods of a year or more, typically leading to rising unemployment. And sometimes we experience booms—periods when output rises rapidly and unemployment falls.

All recessions affect the prosperity and well-being of individuals, although the ‘great recession’ was unusually widespread and, in many countries, unusually deep. Lisa’s story illustrates that booms and recessions—although they may only last a few months or years, and the change in output may sound quite small—can have much bigger and longer-lasting effects on individuals and families. Figure 3.1 shows that Americans experienced many different recession-related hardships during the same period.

The US unemployment rate rose from 5% to 10% between 2007 and 2009; by 2013, it was still around 7%. One in seven of those surveyed had lost a job during this period. One in ten, like Lisa, took on additional jobs. More than 4%, like her, lost their home, and still more were at risk of doing so. Others didn’t suffer such extreme effects, but many struggled with debt, and a high proportion—63% of all respondents—cut back on spending.

gross domestic product (GDP)

A measure of the total output of goods and services in the economy in a given period.

In this unit, we learn about why economies go through upswings, during which aggregate output rises and unemployment falls, and downswings (falling output, rising unemployment). We focus on the total spending (by households, firms, the government, and people outside the home economy) on the goods and services produced by people employed in the home economy. This method gives us a way of measuring the gross domestic product. By itself, GDP does not measure well-being, but it is correlated with some variables that do—such as those included in the UN’s Human Development Index, in the OECD’s Better Life Index (Exercise 3.1)—and to measures of subjective well-being or ‘happiness’.

In Exercise 3.1, we show you a tool that you can use to examine your ideas about how the overall well-being in a country can be compared with well-being in other countries. What is your recipe for a better life in your country? How important do you think unemployment is? Do other things matter more or just as much—for example, good education, clean air, a high level of trust among citizens, high income, or not too much inequality?