December 6, 2023

Economix: After the Fall(s)

The gross domestic product number for the first quarter was disappointing, and came in well below what economists had forecast when the year began. Analysts say that things will probably pick up later in the year, but then, we have heard that before.

Remember the White House’s initial projections about unemployment after the Recovery Act was passed? The prediction was that unemployment would never reach 8 percent. Instead, we haven’t seen unemployment below 8 percent in over two years. Then there was “Recovery Summer,” which actually saw growth slow substantially, followed by subsequent predictions of an imminent acceleration.

Hindsight is 20/20, of course, but in retrospect the projections for an easy, and possibly even “V-shaped,” recovery seem almost comically optimistic. Especially when you look at the history of financial crises and the “lost decades” they can sow.

In a paper presented at the January 2009 meetings of the American Economic Association, Carmen Reinhart and Kenneth Rogoff documented the ugly aftermath of previous financial crises. Looking at over a dozen financial crises in developed and developing countries going back to the Great Depression, for example, they found that the unemployment rate rose an average of 7 percentage points over 4.8 years.

DESCRIPTIONSource: Carmen M. Reinhart and Kenneth S. Rogoff, “The Aftermath of Financial Crises.” Notes from the paper: “Each banking crisis episode is identified by country and the beginning year of the crisis. Only major (systemic) banking crises episodes are included, subject to data limitations. The historical average reported does not include ongoing crises episodes.”

This line of research has been fleshed out in other collaborations, including their book “This Time Is Different: Eight Centuries of Financial Folly,” which Economix readers will recognize as a constant and invaluable reference for this blog.

More recently, Professor Reinhart and her husband Vincent (also an economist) have chronicled the “lost decades” that frequently follow financial crises — i.e., that the damage wrought by a financial crisis can last much longer than “only” a few years, which just a couple of years ago had seemed far too pessimistic. In the abstract they write:

While evidence of lost decades, as in the depression of the 1930s, 1980s Latin America and 1990s Japan are not ubiquitous, G.D.P. growth and housing prices are significantly lower and unemployment higher in the 10-year window following the crisis when compared to the decade that preceded it. Inflation is lower after 1929 and in the post-financial crisis decade episodes but notoriously higher after the oil shock. We present evidence that the decade of relative prosperity prior to the fall was importantly fueled by an expansion in credit and rising leverage that spans about 10 years; it is followed by a lengthy period of retrenchment that most often only begins after the crisis and lasts almost as long as the credit surge.

Hopefully things will pick up later in the year, as economists say. After all, many of the reasons for the slow growth last quarter were, in Ben S. Bernanke’s words, “transitory” (snowstorms, for example, are unlikely to persist through the summer months).

But given the record of other post-crisis recoveries, unfettered optimism — especially when other unknown obstacles, however “transitory,” could knock us off course once again — seems imprudent.

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