In response to the housing bust and its fallout discussed at the end of this chapter, the U.S. economy entered into recession in December of 2007. That recession officially ended in June of 2009, but more than two years later at the end of 2011, many people still felt that the “recession” was not really over. As evidence, they cited high unemployment rates and the failure of some areas of the economy such as the housing market and lending to fully recover. Observers cited lack of confidence and elevated levels of uncertainty for reasons both economic and political. The Federal Reserve implemented several policies to lower both short- and long-term interest rates and increase confidence, but the private sector of the economy did not respond as it had following earlier recessions.
a. Use the AD/AS model to describe how the bursting of the housing bubble affected the economy, how the Fed responded, and the impact it had. In your discussion, be sure to point out which parts of this chapter apply to which behaviors in the economy and which parts apply to the role of the Fed in these events.
b. Critics of the Fed’s response in lowering and keeping interest rates so low for so long argued that the Fed was risking increased inflation. Use the AD/AS model again to explore the validity of these claims.