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The Great Recession: A Self-Fulfilling Global Panic

  • Philippe Bacchetta
  • Eric van Wincoop

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 Université de Lausanne, Faculté des HEC, DEEP in its series Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) with number 13.05.

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Length: 45 pp. + figures (total 60 pp.)
Date of creation: May 2013
Date of revision:
Handle: RePEc:lau:crdeep:13.05
Contact details of provider: Postal: Université de Lausanne, Faculté des HEC, DEEP, Internef, CH-1015 Lausanne
Phone: ++41 21 692.33.64
Fax: +41-21-692.33.65
Web page: http://www.hec.unil.ch/deep/publications/cahiers/series
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