Final answer:
Bank failures can cause recessions by reducing consumer spending and decreasing investment due to limited access to loans, leading to lower aggregate demand and heightened economic uncertainty as seen in the 2008-2009 Great Recession.
Step-by-step explanation:
Bank failures can cause the economy to go into recession through several mechanisms. First, they often lead to a decrease in consumer spending, as people lose confidence in the financial system and become more cautious with their money. Secondly, bank failures can result in decreased investment as the availability of loans becomes restricted, hindering businesses from making capital investments and subsequently leading to job losses and reduced economic activity. Thirdly, the combination of these factors can lead to a sharp reduction in aggregate demand, further exacerbating the downward economic spiral.
The 2008-2009 Great Recession serves as a prime example of this pattern, where the collapse of financial institutions led to a severe credit crunch, reducing both consumer spending and business investment. This resulted in massive unemployment and heightened economic uncertainty, causing a severe recession with global repercussions.