Once a Cassandra, always a Cassandra? That seems to be William White’s fate.
White, the former chief economist of the Bank of International Settlements, is best known for his warnings in 2003 that many advanced economies were in the grip of housing bubbles, which Greenspan pointedly ignored. Although he is now celebrated for that call, his latest, admittedly less dramatic, observations again seem to be falling on deaf ears.
White’s presentation at the Jackson Hole conference (hat tip Richard Alford) has gotten little attention, and that’s a pity, because it contains some useful observations. It focuses on an analysis by Carmen and Vincent Reinhart of economic performance in the wake of severe financial crises. One of White’s astute comments is that weak credit growth may not be due as much to bank reluctance to lend as overextended borrowers getting religion and paying down debt. If lack of loan demand is indeed the main culprit, it says that regulators need not fear imposing tougher bank regulations:
Is the problem of credit de leveraging and increased private sector saving due primarily to a wounded financial system, and a decreased supply of loans, or is it primarily due to decreased demand for credit. This is a crucially important issue for policy. First, if the real problem is a decreased demand for loans, then restoring the financial system to good health will not be sufficient to get the economy expanding again. Second, it also implies that quickly tightening regulation and capital requirements will not hurt the economy as much as might otherwise have been expected….
A hunkering down by debtors, rather than credit restrictions by banks, also seems to me to be consistent with some of the evidence in Reinhart and Rogoff (2009). They note12 that a more normal ordering of events was for the recession to begin first, only followed by financial crises later, as household and corporate bankruptcies began to rise. Finally, as a Canadian, I was also struck by the evidence in Reinhart and Rogoff (2009) that Canada, Mexico and Indonesia suffered greatly during the Great Depression, even though their banking systems remained in quite robust health.
A less polite way to say this is putting the banks at the top of the priority list might not have been the best decision.
Second is his reading of the paper’s methodology, which he believes is likely to wind up overstating how this crisis will work itself out. And note the Reinharts’ forecast is far from cheery:
As to some of the more detailed results from the Reinharts’ paper, per capita growth rates are “significantlyʺ lower in the decade after the crisis than the decade before. Moreover, unemployment rises sharply, and generally does not fall to pre crisis levels even ten years afterwards. House prices also fall sharply (in 10 of the 15 Advanced Market Economies where data is available) and ninety percent of all the observations for house prices in the following ten years remain below pre crisis levels. Finally, the Reinharts underline that financial deleveraging (proxied by debt/GDP) is still going on 10 years after the crisis began. And to these observations we can add some ancillary points from the work of the IMF and the OECD. They note that household saving rates also rise very sharply in recessions following financial crises, while private investment also falls dramatically.
White finds multiple reasons to think recovery will trail these norms. Not surprisingly, the amplitude of the unwind tends to be proportional to how big the bubble was, and this last one was pretty large. Second, excessive concern with sovereign debt levels could make matters worse (and note White buys the idea that higher sovereign debt levels can slow growth):
These last points raise the obvious question of what else adjusts to satisfy the identity for saving and investment in the National Income Accounts [what has to adjust to accommodate the increase in household and business savings]. The answer given by the IMF is that the identity is typically closed by very significant increases in government deficits 9as well as major increases in exports. Of course the obvious corollary to these latter two points is less comforting in current circumstances. If government deficits are not allowed to rise, say because debt levels are already judged to be dangerously high, and if exports cannot go up because the downturn is occurring simultaneously across a number of countries, then the resulting recession could be significantly more serious than was typical after past financial crises.
White also does not subscribe to the “better policy responses mean recovery is just around the corner” thesis:
….one crucial fact that emerges from the Reinharts’ work, and that of others. It is that the deep slumps after financial crises all look very much the same. Are we to believe that there was policy error [after the crisis] in every case?
Finally, White contends that more should be done to restructure borrowers’ debts:
….we need to put more effort into debt restructuring, recognizing that half a loaf is always better than no loaf. This applies to household debt, corporate debt and the debt of financial institutions.
White is apparently quite busy in his supposed retirement. but his sensible remarks don’t seen to get much coverage in the US. probably because he’s shown himself not to be terribly taken with received wisdom.