Economists Carmen Reinhart and Kenneth Rogoff have been publishing various findings from a large-scale data set they have constructed of past financial crises. They have looked back as far as 800 years, but not surprisingly, most of their output has consisted of analyses of modern crises (you can find some earlier discussions here and here).
They have released a summary of a presentation that they will present this weekend at the AEA conference. It’s refreshingly straightforward, and offers some sobering implications for our current. mess.
Their work has shown that financial crises are more severe and protracted than “normal” recessions. In some of their previous presentations, they had parsed out financial crises in advanced economies versus those in developing countries, and were surprised to find their trajectories were remarkably similar, so their latest product looks at both types together. It also includes two prewar developed country episodes where Reinhart and Rogoff had sufficient housing price and other relevant data.
Their latest piece looks at how crises generally progress and resolve themselves. The usual outcomes are worse than most commentators forecast for the US (save the fall in average real estate prices):
1. Real housing price declines average over 35% over a six year period. Note in other crises, residential real estate was not necessarily a focus of the bubble. Even excluding Japan (which has suffered a 17 year housing price decline) the average is over 5 years.
2. Equity prices fall 55% over three and a half years.
3. GDP fall an average of 9% (read that twice)
4. Unemployment increases 7% over previous norms.
5. Government debt “explodes”, increasing an average of 86%, but the cause is typically not a banking industry recapitalization, but maintaining services in the face of collapsing tax revenues and countercyclical measure ex financial system measures.
Note the sample included countries subjected to IMF bailout requirements 1990s Asian crisis, like Indonesia and Thailand, which led to dramatic declines in output and sharp increases in unemployment, but (at least as popularly reported) sharp rebounds from the trough.
Other comments from the paper:
The housing price decline experienced by the United States to date during the current episode (almost 28 percent according to the Case–Shiller index) is already more than twice that registered in the U.S. during the Great Depression..
It is interesting to note …that when it comes to banking crises, the emerging markets, particularly those in Asia, seem to do better in terms of unemployment than do the advanced economies. While there are well-known data issues in comparing unemployment rates across countries, 3 the relatively poor performance in advanced countries suggests the possibility that greater (downward) wage flexibility in emerging markets may help cushion employment during periods of severe economic distress….
How relevant are historical benchmarks for assessing the trajectory of the current global financial crisis? On the one hand, the authorities today have arguably more flexible monetary policy frameworks, thanks particularly to a less rigid global exchange rate regime. Some central banks have already shown an aggressiveness to act that was notably absent in the 1930s, or in the latter-day Japanese experience. On the other hand, one would be wise not to push too far the conceit that we are smarter than our predecessors. A few years back many people would have said that improvements in financial engineering had done much to tame the business cycle and limit the risk of financial contagion.
Since the onset of the current crisis, asset prices have tumbled in the United States and elsewhere along the tracks lain down by historical precedent…..The global nature of the crisis will make it far more difficult for many countries to grow their way out through higher exports, or to smooth the consumption effects through foreign borrowing. In such circumstances, the recent lull in sovereign defaults is likely to come to an end.