There has been a consistent effort by pundits on the right to characterize our current financial crisis as being just like every other recession. They have tried to characterize recessions brought on by bank runs from failed efforts to corner a market as being equivalent to our current crisis which is international in nature and entailed record amounts of personal and corporate debt. Schularick and Taylor have looked at what should have been clear to anyone with a modicum of interest in the topic. What do recoveries with a financial crisis* and very large levels of private debt look like? Do the deeper output drops associated with a financial crisis mean a faster recovery? The authors note that you simply don’t have enough of these kinds of crises if you limit your sample to the US.
Can economic history cast light here? We share concerns that short-broad datasets for postwar emerging markets may not be a suitable benchmark for most advanced countries. And long-narrow samples using a single country (e.g., the US) may provide too few recession observations for robust inference. Such doubts provide an argument for a different type of analysis, i.e. an approach focusing only on the experience of advanced countries, so as to better focus the lens of history for current observers.
We reach back into the historical record over 140 years, examining the experiences of 14 advanced countries, to document the pervasive cyclical influence of credit in the economic fortunes of nations (Jordà et al. 2011). This dataset is not a sample; it is close to the entire population, so better evidence may be hard to find.
With that in mind, we set out to address two key questions:
Are financial-crisis recessions and recoveries significantly different – that is, more painful – than normal recessions?
Is the intensity of credit creation, or leveraging, in the preceding expansion phase systematically related to the severity of the subsequent recession phase?
The answer to both questions appears to be yes, and therein lie the lessons that can inform our current economic outlook.
The authors go on to lay out their methods. Of import, they note the impact of the shadow banking sector. They conclude that financial crises with large credit expansions are associated with extended, slow recoveries. Compared with other recoveries, our current one is stronger than an average recovery with similar conditions.
By this reckoning the US has done quite well, steering out of the to-be-expected financial recession range based on the inherited level of excess credit, especially if the shadow system is considered. Most importantly a deep financial recession was avoided at the outset, and this level effect remained intact.
Seeing this US outperformance it may be tempting for readers to map the paths into policy shifts. The extraordinary, coordinated central bank and fiscal actions of 2008–09, both globally and in the US (Fed liquidity and QE1 programs and the ARRA stimulus); and then the arguably premature tapering of such policy supports (Fed dithering over QE/twist programs, and the phase out of ARRA with no further stimulus). We think such conjectures represent fertile ground for future research…
To assume that this US recovery would resemble previous “normal recession” is to use the wrong benchmark. Such forecasts risk overstating growth, lending, interest rates, investment, and inflation. Our work shows that the leverage run-up was unusually high going in, so as in the past it is unsurprising that a painful deleveraging dynamic is taking its toll on the way out.
This time actually is different – and worse – in one very clear and measurable dimension. Now, as in past debt overhangs for more than a century, credit has exerted a crucial influence on the course of the business cycle.
I suspect this is intuitively obvious to most people if they think about it. We know that there are large shadow inventories in private and commercial real estate hanging around. These markets are unlikely to heal until these inventories are worked off. People know that that they took out home equity loans when the real estate market was booming. They assumed that there homes would continue appreciating in value. All of the experts told them this was safe. Now, they still have those loans, and homes that are underwater. Even if they can make the payments, they are stuck with the debt that cannot be paid off in time of need by selling the house, the back up plan if things went bad. We talk about public debt and its potential fro slowing the economy, yet surely people also realize that business owners saddled with record levels of debt are not going to be taking out new loans.
As the authors note, this time really is different. The cottage industry devoted to denying this has its own goals. Truth is not one of them.
*Efforts to mischaracterize the current recovery have been successful at obscuring the meaning of this term. They use it in an overly broad manner to obscure, rather than illuminate, the nature of our current problems.