Friday, October 26, 2012

Financial crises and recessions/depressions

It seems to be pretty generally accepted among Keynesian economists - to the extent someone not a professional economist can hazard such a generalization - that periods of economic downturn started by a systematic financial crisis require longer recovery times than others. Carmen Reinhart and Kenneth Rogoff in Sorry, U.S. Recoveries Really Aren’t Different Bloomberg View 10/15/2012 take a look at the depressions they see as most comparable to the current situation, those of 1873, 1893 and 1907 (which were called "panics" at the time) and the Great Depression of 1929. They write of the 2007 crisis:

The most recent U.S. crisis appears to fit the more general pattern of a recovery from severe financial crisis that is more protracted than with a normal recession or milder forms of financial distress. There is certainly little evidence to suggest that this time was worse. Indeed, if one compares U.S. output per capita and employment performance with those of other countries that suffered systemic financial crises in 2007-08, the U.S. performance is better than average.

This doesn’t mean that policy is irrelevant, of course. On the contrary, at the depth of the recent financial crisis, there was almost certainly a risk of a second Great Depression. However, although it is clear that the challenges in recovering from financial crises are daunting, an early recognition of the likely depth and duration of the problem would certainly have been helpful, particularly in assessing various responses and their attendant risks. Policy choices also matter going forward.
The history of those events also indicates that, absent offsetting policy choices, we can expect employment recovery to be slow:

These historical U.S. episodes are in line with the 2010 findings of Carmen and Vincent Reinhart, who examine severe/systemic financial crises in both advanced economies and emerging markets in the decade after World War II. They document that in 10 of 15 episodes the unemployment rate had not returned to its pre-crisis level in the decade after the crisis. For the 1893 crisis and the 1929 Depression, it was 14 years; for 1907, it took 12 years for the unemployment rate to return to its pre-crisis level.
Paul Krugman emphasizes that this is no reason to look at such results as inevitable (Bubble, Bubble, Conceptual Trouble 10/20/2012):

I get a lot of complaints that people like me are being inconsistent: we say that financial crises are usually followed by prolonged slumps, yet we also want to End This Depression Now! and claim that it could be done very quickly. But there’s no inconsistency: there are simple policy actions that could quickly end this depression now, there were simple policy actions that could have quickly ended depressions past. The problem is that now and then policy makers tend not to take these actions — which is why some of us write books. ...

One last point: we still keep hearing the "structural" argument, that we have to expect prolonged high unemployment because it takes time to turn construction workers into manufacturing workers or whatever. One answer is that this portrait of the economy is factually wrong: job losses have not been concentrated in a few sectors or professions, they have been broadly spread across the economy. But there’s also a conceptual answer: if shifting workers across sectors requires mass unemployment, how come the bubble years — when we were moving out of manufacturing into housing — weren’t high-unemployment years? Why does moving into the bubble sectors mean more jobs, but moving out into other sectors mean fewer jobs? I’ve never heard a coherent answer.

Back to the main point: yes, the aftermath of crises is usually a bad time. But that’s because the policy response to crises is usually lousy. We are repeating that story — but we shouldn’t. [my emphasis]
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