US recession history not repeating

The US has rebounded better than other advanced economies, but famous economists advising the Romney campaign claim this is not good enough. The US, they argue, is different. But history suggests otherwise.

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Sources: Reinhart and Rogoff (2009), Maddison (2006), GDP per capita from Total Economy Database, Conference Board. Notes: Total GDP per capita in 1990 US dollars (converted at Geary Khamis PPPs).

The ‘US is different’ idea is not supported by the unemployment data

The notion the US exhibits rapid recovery from systemic financial crises does not emerge from the unemployment data either. As we noted, the US unemployment rate data only begins in 1890, which eliminates the 1873 crisis from the pool. The aftermath of remaining four crises are shown in Figure 2.

The 2007 crisis is associated with significantly lower unemployment rates than both the Depression of the 1930s and the depression of the 1890s.
2007 it is more in line with the unemployment increases observed following the Panic of 1907. As shown in the inset to the figure, the unemployment rate, which was 1.7 per cent in 1906 was near 6 per cent five years later.

In the 1892 crisis, the unemployment rate started at 3 per cent in 1892, shot up to over 18 per cent, and still remained above 14 per cent in 1896.
In effect, the unemployment never dips back to below 3 per cent until 1906 (on the eve of the next crisis). The pattern during the Great Depression of the 1930s, is off the charts (Eichengreen and O Rourke, 2010 is a must read on this comparison). These historic US episodes are in line with the findings in Reinhart and Reinhart (2010), who examine the decade after post-WWII severe/systemic financial crises in both advanced economies and emerging markets, documenting that in ten of the 15 episodes examined the unemployment rate had not returned to its pre-crisis level in the decade following the crisis.

For the 1893 and 1929 Depression it was 14 years; for 1907 it was 12 years before the unemployment rate went back to its pre-crisis level.

Figure 2. Average annual unemployment rate in the aftermath of systemic banking crises in the US, 1892-2011

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Sources: Bureau of Labor Statistics, Historical Statistics of the US, and Reinhart and Rogoff (2009). Notes: Average annual unemployment rates. The change from the level at the outset is the simple difference; for example the unemployment rate in 2007 was 4.6 per cent so the difference from 2011 (when the unemployment rate is 9 per cent) is 4.4 per cent.

Chart the cross-country real per capita GDP comparisons: 2007-2011

We next turn to comparisons between the US and other countries in the Second Great Contraction. The simplest of cross-country comparisons involves dividing the post-2007 crisis experience into two batches:

Those countries that experienced systemic banking crises; and
Those that had milder borderline problems in their financial sector (which does not preclude them from having other serious 'varieties' of crises, notably fiscal in this case.)
This applies the same criteria as Reinhart and Rogoff (2008). Figure 3 presents the evolution of per capital GDP normalised to equal 100 in 2007. The inset in the chart indicates which countries are included in the averages for the systemic and borderline episodes.

Figure 3. Real per capita GDP (levels): 2007-2011 systemic and borderline crises in advanced economies

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Sources: Laeven and Valencia (June 2012), Reinhart and Rogoff (2009), GDP per capita from Total Economy Database, Conference Board. Notes: Total GDP per capita in 1990 US dollars (converted at Geary Khamis PPPs). For further details on the distinctions between numerous dimensions of the systemic-borderline distinctions since 2007, see Laeven and Valencia (2012). Italy and Portugal post the weakest output performance among the borderline cases, as these countries face additional concerns about their sovereign debt sustainability. For Austria, Germany, The Netherlands and Switzerland peak per capita GDP was 2008. For all others the peak was 2007.

The pattern described in Reinhart and Rogoff (2008) for 1946-2006 crises is replicated in the cross-country performance in the recent (2007-2011) crises: the systemic crises are associated with deeper more protracted recessions than the borderline cases – notwithstanding the fact that some of the borderline banking crises cases (to-date ) involve serious fiscal crises as well, including for example Portugal and Italy where growth and employment performance has been miserable.

Note that the US per capita GDP contraction since 2007 shows a comparable initial decline as that recorded in the other European countries (since 2007) undergoing systemic financial crises but a faster recovery in the subsequent years.

Summary and concluding remarks

While no two crises are identical, there are some robust recurring features of crises that cut across time as well as across national borders. Common patterns as regards the nature of the long boom-bust cycles in debt and their relationship to economic activity emerge as a common thread across very diverse institutional settings. This, in fact, is precisely a key if surprising takeaway from our 2009 book.

The most recent US crisis appears to fit the more general pattern that the recovery process from severe financial crisis is more protracted than from a normal recession or from milder forms of financial distress. There is certainly little evidence to suggest that this time was worse.

Of course this does not mean policy is irrelevant. Quite the contrary, in the heat of the recent financial crisis, there was almost certainly a palpable risk of a Second Great Depression. However, although it clear that the challenges in recovering from a financial crises are daunting, an early recognition of the likely depth and duration of the problem would certainly have been helpful. It would have been helpful in assessing various options and their attendant risks. It is not our intention here to closely analyse policy responses that frankly, may take years of analysis to sort out.

Rather, our aim is to clear the air that somehow the US is different. The latest US financial crisis, yet again, proved it is not.

Carmen M Reinhart is senior fellow, Peterson Institute for International Economics. Kenneth Rogoff is the Thomas D. Cabot Professor of Public Policy and Professor of Economics at Harvard. Reinhart and Rogoff are the authors of This Time is Different: Eight Centuries of Financial Folly, (Princeton University Press, 2009).

Originally published on
www.VoxEU.org. Reproduced with permission.

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