Afternoon Must-Read: Nick Bunker: Are recoveries from Financial Crises Always Slow?

…When economies go through major systemic failures of their financial systems the ensuing economic recoveries will invariably be tepid and prolonged. This view is based primarily on research by economists Carmen Reinhart and Kenneth Rogoff…. Christina D. Romer and David H. Romer… is a refinement of those analyses… focused specifically on financial crises in rich economies in the latter half of the 20th century…. Very large financial crises… Sometimes, as in the case of Japan, the crisis leads to significant recessions and slow recoveries. And sometimes, such as with Norway in the early 1990s, the effect was pretty much non-existent…. A large financial crisis doesn’t necessarily mean a large economic downturn has to happen. Economic events aren’t forces that sweep over us, but things that we can react to and very possibly control.

…There’s every reason to think that the same thing will happen this time…. The 1990-91 recession was brought on by a credit crunch, the 2001 recession by overinvestment; this time we’ve got both. I guess we’ll see. In any case, whatever happens will probably last quite a while.

…based on assessments of the health of countries’ financial systems from a consistent, real-time narrative source…. We find that output declines following financial crises in modern advanced countries are highly variable, on average only moderate, and often temporary. One important driver of the variation in outcomes across crises appears to be the severity and persistence of the financial distress itself.

…Five to six years after the onset of the current crisis only Germany and the United States… have reached their 2007–2008 peaks in per capita income…. The sub-prime crisis is not an anomaly in the context of the pre-WWII era. Postwar business cycles are not the right comparator for the severe crises that have swept advanced economies in recent years….

Even after one of the most severe multi-year crises on record in the advanced economies, the received wisdom in policy circles clings to the notion that high-income countries are completely different from their emerging-market counterparts… growth, financial stability, and debt sustainability can be achieved through a mix of austerity and forbearance (and some reform). The claim is that advanced countries do not need to resort to the more eclectic policies of… debt restructurings and con- versions, higher inflation, capital controls, and other forms of financial repression.

Now entering the sixth or seventh year (depending on the country) of crisis, output remains well below its pre-crisis peak in ten of the twelve crisis countries. The gap with potential output is even greater. Delays in accepting that desperate times call for desperate measures keeps raising the odds that, as documented here, this crisis may in the end surpass in severity the depression of the 1930s in a large number of countries.

…Financial stability risks have been increasingly linked to real estate lending booms which are typically followed by deeper recessions and slower recoveries.” |

Sovereigns versus Banks: Credit, Crises, and Consequences: In advanced countries since 1870… significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt. However… high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises…. (i) In a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; (ii) the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and (iii) the path of recovery is worse still when a credit-fueled crisis coincides with elevated public debt levels…. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now.”