Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Considering the Lessons of the 2008 Financial Crisis


In This Chapter


Understanding the causes of the crisis


Seeing why no one could predict the crisis


Taking actions to prevent future crises
The 2008 global financial crisis was painful for people all over the world: many countries went into recession, living standards fell, assets such as houses and shares experienced large falls in value, businesses went bankrupt and people lost their jobs. Given the enormous negative impact of financial crises, the question is: is it likely to happen again, and if so can policy makers and/or economists do anything to reduce its frequency and impact?

The fact that such a major crisis occurred with few – if any – economists predicting it led to a wave of criticism of economics and economists. After all, they’re constantly reminded, what’s the point of having economists if they can’t even predict when crises will occur?

We argue that a lot of this criticism is misplaced and that economists have never claimed to be able to predict financial crises. On the contrary, economic theory suggests that financial crises are inherently unpredictable! In this chapter we explain why and take a closer look at the causes of the 2008 crisis to see what lessons can be learned.

Delving into the Global Financial Crisis

We’re going to let you in on a little secret, but please don’t tell anyone:

economists don’t really understand why financial crises occur. They can point

to general factors that contribute to financial fragility, such as those we cover in Chapters 14 and 15, but they’re very far from having a general theory to explain, let alone predict, financial crises.


This situation isn’t really surprising, because modelling the economy is a tricky business: at any moment in time large numbers of individuals and firms are all making their own decisions. These individual choices need to be aggregated in some way in order to reveal how the economy as a whole is going to behave. During times of crisis, doing so is even more difficult, because people become uncertain and fearful, which affects their ability to make rational decisions.


Despite these problems, whenever a crisis hits you find no shortage of

commentators who are confident that they ‘know’ exactly the cause. Always be sceptical of such claims, because the cause of financial crises is very much an open question and one about which macroeconomists disagree the most.

Nevertheless, a popular narrative does exist about why the 2008 crisis occurred. In this section we go through this account and describe the roles of subprime lending, securitisation and leverage. Read and understand it, but also take it with a pinch of salt, because – for the reasons above – it’s unlikely to be the full story.