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The unexpected global financial crisis : researching its root cause

Author

Listed:
  • Lin, Justin Yifu
  • Treichel, Volker
Abstract
The world is currently still struggling with the aftermath of the worst economic crisis since the Great Depression. Following a description of the eruption, evolution and consequences of the global crisis, this paper reviews alternative hypotheses for the causes of the global financial crisis as well as their empirical evidence. The paper refutes the frequently voiced view that the global crisis was caused by global imbalances that reflected economic policies of East Asian countries. Instead, it argues that global imbalances were the result of excess demand in the United States, resulting from both the public debt in the United States arising from the Afghanistan and Iraqi wars and tax cuts and the overconsumption by households supported by the wealth effect from the housing bubble in the United States. The housing bubble itself was the outcome of the Federal Reserve's low interest rate policy in the aftermath of the burst of the"dot-com"bubble in 2001, the lack of appropriate financial regulation, and housing policies aimed at expanding the mortgage market to low-income borrowers. It was possible to maintain the large trade deficits of the United States for such a long period of time because of the dollar's reserve currency status. When the housing bubble in the United States burst, the global crisis ensued. The paper also analyzes why China's trade surplus increased significantly in general and with the United States in particular in recent years, and argues that this increase was caused by both the relocation of the labor-intensive tradable sector of East Asian economies to China and high corporate saving rates in China as a result of its dual-track approach to reform.

Suggested Citation

  • Lin, Justin Yifu & Treichel, Volker, 2012. "The unexpected global financial crisis : researching its root cause," Policy Research Working Paper Series 5937, The World Bank.
    • Handle: RePEc:wbk:wbrwps:5937
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    References listed on IDEAS

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    Cited by:

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    2. Alviarez, Vanessa & Cravino, Javier & Levchenko, Andrei A., 2017. "The growth of multinational firms in the Great Recession," Journal of Monetary Economics, Elsevier, vol. 85(C), pages 50-64.
    3. Dethier, Jean-Jacques & Morrill, Curtis, 2012. "The great recession and the future of cities," Policy Research Working Paper Series 6256, The World Bank.
    4. Fred Thompson, 2012. "Debate: Financial panic, economic threat, and sovereign debt crises," Public Money & Management, Taylor & Francis Journals, vol. 32(3), pages 164-165, May.
    5. Giambattista Salinari & Federico Benassi, 2022. "The long-term effect of the Great Recession on European mortality," Journal of Population Research, Springer, vol. 39(3), pages 417-439, September.
    6. Lin, Justin Yifu & Treichel, Volker, 2012. "The crisis in the Euro zone : did the euro contribute to the evolution of the crisis ?," Policy Research Working Paper Series 6127, The World Bank.
    7. Dias, Rui & da Silva, Jacinto Vidigal & Dionísio, Andreia, 2019. "Financial markets of the LAC region: Does the crisis influence the financial integration?," International Review of Financial Analysis, Elsevier, vol. 63(C), pages 160-173.
    8. Claudeci Da Silva & Hugo Agudelo Murillo & Joaquim Miguel Couto, 2014. "Early Warning Systems: Análise De Ummodelo Probit De Contágio De Crise Dos Estados Unidos Para O Brasil(2000-2010)," Anais do XL Encontro Nacional de Economia [Proceedings of the 40th Brazilian Economics Meeting] 110, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].

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