Abstract: The Great Global Contagion and Recession was largely the result of a sustained global savings glut combined with excessive monetary accommodation by the Federal Reserve and other central banks.
These two complementary and reinforcing forces artificially depressed the price of risk globally, leading to the widespread mis-pricing of assets and misallocation of investment.
These effects were enhanced by rapid financial innovation and breathtaking arrogance of leading financial market participants in believing that they understood these innovations.
The Great Global Recession began in the United States in December 2007 and will likely continue well into 2010 in many parts of the world.
The global contagion began in March 2008 with the collapse of the investment house Bear Stearns.
Citizens, analysts, and policymakers are appropriately anxious to understand how this disaster came about and what can be done to prevent a repetition. housing sector, housing finance, and even the United States in general fail to explain the global financial contagion and global recession.
At the outset of the recession, various theories were proposed to explain who or what was at fault, but most have long since fallen by the wayside as events outgrew the theories. The global nature of the financial contagion and recession strongly suggests that the essential cause or causes must be global, rather than country-specific.
In coming years a consensus will unfold as to the causes and contributing factors of this global contagion and recession.
However, two theories already stand out, one centered on monetary policy and the other centered on an exceptional, sustained surge in global savings.
Neither explanation precludes the other from playing a major role.
On the contrary, the theories describe complementary, mutually reinforcing economic forces.
Understanding the causes of the Great Global Contagion and Recession is not merely a matter of history.
It is also important for interpreting events and anticipating problems in the near term as economies around the world struggle to regain vitality.
Clearly identifying the true causes and discarding the false ones is also important as policymakers attempt to create new protections against a repetition.