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The Great Recession: A Self-Fulfilling Global Panic

  • Philippe Bacchetta

    (University of Lausanne, Swiss Finance Institute, Centre for Economic Policy Research and Hong Kong Institute for Monetary Research)

  • Eric van Wincoop

    (University of Virginia, National Bureau of Economic Research, and Hong Kong Institute for Monetary Research)

While the 2008-2009 financial crisis originated in the United States, we witnessed steep declines in output, consumption and investment of similar magnitudes around the globe. This raises two questions. First, given the observed strong home bias in goods and financial markets, what can account for the remarkable global business cycle synchronicity during this period? Second, what can explain the difference relative to previous recessions, where we witnessed far weaker co-movement? To address these questions, we develop a two-country model that allows for self-fulfilling business cycle panics. We show that a business cycle panic will necessarily be synchronized across countries as long as there is a minimum level of economic integration. Moreover, we show that several factors generated particular vulnerability to such a global panic in 2008: tight credit, the zero lower bound, unresponsive fiscal policy and increased economic integration.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 092013.

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Length: 53 pages
Date of creation: Jun 2013
Handle: RePEc:hkm:wpaper:092013
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