Business, Community & Government

The Economic Theory of Crises

Paul Krugman

Lesson time 08:53 min

Learn how these concepts played out in Japan's 1998 crash and the 2008 recession in the US.

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Topics include: The Zero Lower Bound • Visualizing Liquidity Traps: No Traction, No Inflation


The Great Recession of 2008 had a lot of people questioning what a recession was—and why it happened in the first place. History provides invaluable lessons to economists who study upturns and downturns, but it is also important for the average citizen to understand how consumer behavior may impact markets, especially those that end up in a significant decline. What Is a Recession? A recession is a slow down or contraction of the economy over a business cycle. The period of time and what exactly indicates a recession are not tightly defined. Some countries and economists define a recession as a contraction over two consecutive quarters, some define it as six months, and some do not define the time period at all taking a more complete and nuanced view of different data points to indicate a recession. What Causes a Recession? Negative Gross Domestic Product (GDP) growth, a reduction in consumer spending and in asset prices, and drops in the stock market and in interest rates are all indicators of a recession. Recessions, and therefore things like negative GDP growth, unemployment, drops in interest rates and asset prices, etc., have been caused by bank runs and asset bubbles (see below for explanations of these terms). What Are the Indicators of a Recession? There are a number of factors that can indicate a recession: - A rise in unemployment - A rise in bankruptcies - Lower consumer spending and consumer confidence - A reduction in asset prices This includes the cost of homes, and a fall in the stock market, to name the main indicators. All of these factors can lead to an overall contraction of the Gross Domestic Product. The European Union and the United Kingdom define a recession as two or more consecutive quarters of negative real GDP growth. In the United States, the National Bureau of Economic Research (NBER) tracks the indicators of a recession, and will determine whether the US economy is in recession. The NBER takes into account many different factors, like those listed above, to determine whether the US economy is in recession. For example, the NBER declared a recession in the early 1990s even though the GDP contracted three quarters, none of them consecutive. The yield curve is another indicator of recessions, and one the NBER also uses to predict or declare a recession. A yield curve is a line on a graph that tracks the interest rates of bonds that are equal in credit but have different times at which they mature. A common yield curve looks at US Treasury Debt at three month, two year, five year, ten year, and 30 year maturity benchmarks. There are three different types, or shapes, or a yield curve that indicate different stages of economic growth. 1) Normal A normal yield curve means that longer term bonds have a higher yield than short term bonds. This generally indicates a healthy economy and positive economic growth. 2) Flat A flat yield curve means that longer term bonds are beginning to...

About the Instructor

For Nobel Prize-winner Paul Krugman, economics is not a set of answers—it’s a way of understanding the world. In his economics MasterClass, Paul teaches you the principles that shape political and social issues, including access to health care, the tax debate, globalization, and political polarization. Heighten your ability to read between the lines and decipher the underlying economics at play.

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Paul Krugman

Nobel Prize-winning economist Paul Krugman teaches you the economic theories that drive history, policy, and help explain the world around you.

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