How New Is the Normal?
Are financial recessions not special?Some new findings from the Board of Governors' research team suggest a banking and financial (B&F) crisis has little explanatory power for the way economies recover from recessions.
This runs in some ways contrary to what had been considered authoritative findings from Reinhard and Rogoff which argued that a B&F crisis tends to lead to a prolonged, deep recession and a delayed, anemic recovery.Focusing specifically on the performance of output after the recession trough, we find little or no difference in the pace of output growth across types of recessions. In particular, banking and financial crisis do not affect the strength of the economic rebound, although these recessions are more severe, implying a sizable output loss. However, recovery does change with some characteristics of recession. Recoveries tend to be faster following deeper recessions, especially in emerging markets, and tend to be slower following long recessions.
Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes. Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system.That is certainly true -- but the new finding argues that this relationship is not causal, i.e., it is the deep and prolonged drop in output and incomes which determines the nature of the recovery.
For a more precise and math-oriented understanding, the new research took four metrics -- (1) the depth of the recession, (2) the duration of the recession, (3) the rate of pre-crisis growth, and (4) the presence or non-presence of a B&F crisis -- and used linear regression to determine the impact and significance of these four items on recoveries one, two, and three years out. At all points, item four -- the B&F crisis -- was judged to have statistically insignificant impact on recoveries when one had factored in the unusual severity and length of the accompanying recession.