Hopefully, that will prevent the situation from spinning out of control and igniting a wider financial crisis in Europe. In addition to the actions of European political leaders, central banks have been actively supplying liquidity to the European banking system. The Fed set up temporary currency  BIS central bankers’ speeches  3  swap lines with several foreign central banks last November. These lines allow those central banks to borrow dollars and, in turn, lend those dollars to banks in their countries. In addition, the European Central Bank has provided hundreds of billions of euros in three-year loans to European banks. These actions have defused concerns about the ability of European banks to renew credit when their debts come due. In this way, Europe has avoided what could have been a massive credit crunch as banks pulled back lending sharply. I don’t need to remind you that, in today’s interconnected world, financial turmoil in Europe would definitely hurt our economy as well. Even if the European crisis doesn’t flare up again, growth is slowing in many parts of the world. Many European countries already appear to be in recession, and there is a danger that this situation could worsen significantly as governments put in place austerity measures. Turning to Asia, growth in China has also slowed as that country has tightened monetary and credit policies to reduce inflation. Indeed, the list of countries that are still experiencing solid growth is getting shorter all the time.
Between 1999 and 2006, housing debt more than doubled.3 So it’s not so surprising that we got an anemic rebound. The financial crisis unleashed powerful forces that have damped spending and sapped the recovery of its vigor. I’ll mention three. First, it destroyed a huge amount of household wealth. Second, it flattened the housing market. Third, it made it hard for businesses and households to get credit. Let’s look at each of these. First, when house prices collapsed, the wealth of American households plunged by about six-and-a-half trillion dollars. That equals more than 40 percent of the total size of the U.S. economy. Many people went from feeling rich to feeling poor, with neither the means nor the will to spend. Instead, they became intent on repairing their finances by increasing their saving and trimming their debt. In other words, they deleveraged. During the recession, the household saving rate climbed to about 6 percent of income from about 1 percent. It’s still about 4-1/2 percent. In the long run, higher saving is healthy. But, in the near term, it puts a brake on spending and slows growth. Second, the depressed housing market has been a drag on growth. Home construction plays an important role in the economy, of course. When you add in items that often go with a new home – things such as furniture, carpets, and appliances – you’re talking about a significant fraction of overall economic activity.4 Today, there are still millions of homes in foreclosure, and millions more on the verge.