August 06, 2008
Synergies of the unpleasant kind: recessions, credit crunches and housing busts
From the abstract of a new paper by Stijn Claessens, M. Ayhan Kose and Marco E. Terrones, entitled "What Happens During Recessions, Crunches and Busts?" (paper now online here):
We provide a comprehensive empirical characterization of the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the 1960-2007 period. In particular, we analyze the implications of 122 recessions, 112 (28) credit contraction (crunch) episodes, 114 (28) episodes of house price declines (busts), 234 (58) episodes of equity price declines (busts) and their various overlaps in these countries over the sample period. We document a rich set of stylized facts about the behavior of key macroeconomic and financial variables during these various events. Our results indicate that interactions between macroeconomic and financial variables can play major roles in determining the severity and duration of a recession. In particular, we show that recessions associated with credit crunches and house price busts are deeper and last longer than other recessions are. In light of our findings, we examine the implications of recent macroeconomic and financial developments in the United States for the future path of its economy.
With respect to ongoing events in the United States, they write:
These comparisons suggest that, while the current slowdown may share some features with the onsets of typical U.S. and OECD recession, it is worse in some dimensions, particularly in terms of speed of credit contraction, drop in residential investment and decline in house prices. We therefore also compare the developments in credit and housing markets in the United States to date to those in the past episodes of credit contractions and house price declines. Tables 2B and 3B showed that such credit contraction (crunch) and house price decline (bust) episodes on average lasted 6 (10) and 8 (18) quarters, respectively. If these statistics, based on a large number of episodes, provide any guidance, they suggest that the adjustments of credit and housing markets in the United States are only in the early stages relative to historical norms and might still take a long time. The earlier episodes suggest that the process of adjustment in the United States might persist in the coming months with further difficulties in credit markets and drops in house prices. This could bode consequently poor for the path of overall output, which, as we showed, falls more in recessions associated with credit crunches and house price busts than in recessions without such events.
Excerpt from Figure 9 from Claessens, Stijn and Terrones. The solid line denotes the current U.S. slowdown. The light solid line is median of all recessions in OECD countries (except the United States) while the dotted lines correspond to upper and lower quartiles of these recessions. The dashed line is the median of all U.S. recessions. Zero is the quarter after which a recession begins (peak in the level of output).
Excerpt from Figure 9 (continued) from Claessens, Stijn and Terrones. The solid line denotes the current U.S. slowdown. The light solid line is median of all recessions in OECD countries (except the United States) while the dotted lines correspond to upper and lower quartiles of these recessions. The dashed line is the median of all U.S. recessions. Zero is the quarter after which a recession begins (peak in the level of output). Short-term interest rate is the change in the level.
What this tells me is that while we might be seeing the bottom of the housing decline, it will likely take a long time for us to crawl out of this housing trough. (Personally, I'm not too confident about the conclusion we have hit the bottom).
The preceding takes current observations on the US experience, and places them against the average of preceding events. What to make of prospects for the US economy? Peter Hooper, Thomas Mayer, and Torsten Slok undertake an analysis, similar to that conducted in the Greenlaw, Hatzius, Kashyap, Shin study discussed in this post, and write in the July 28 issue of Deutsche Bank's Global Economic Perspectives (not online):
The need for a reduction of the level of leverage of financial institutions and its potential implications for the economy at large has been the subject of a controversial discussion. In a paper titled "Leveraged losses" presented at the conference of the US Monetary Policy Forum (MPF) in February 2008 the authors estimate that the de-leveraging of US financial institutions would lead to a reduction of credit to US non-levered entities by about USD1 trillion (4.4% of the total assets of the US financial sector) and shave about 1.3 percentage points off GDP growth over the year following the negative credit shock (in addition to the effects from other transmission channels). A number of public commentators have found these numbers hard to believe and several economists have criticised the study on methodological grounds. In the following we use more recent data for analyzing the size of the de-leveraging and a slightly different method to assess its implications. Our analysis suggests a substantially larger cut-back in the credit supply than estimated by the MPF paper (14.5% of assets in the US). ... Using a different methodology to estimate the effect of the credit tightening on US GDP growth, we find that the negative effects will play out over a considerable period, shaving about 1.5 percentage points off US GDP growth (and something approaching that amount off euro area growth) over the next three years.
Posted by Menzie Chinn at August 6, 2008 12:45 PMdigg this | reddit
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» August 7, 2008 from PrefBlog
Menzie Chinn of Econbrowser passes along a very gloomy paper on the interaction of recessions, credit contractions, housing price declines and stock market declines: In particular, we show that recessions associated with credit crunches and house price... [Read More]
Tracked on August 7, 2008 06:45 PM
The results of the Claessens, Kose and Terrones paper above were already confirmed earlier for the case of housing and equities in the paper "Measuring the Macroeconomic Risks Posed by Asset Price Booms" by Professor Stephen Cecchetti here:
Also, I can think of many reasons why home prices should continue lower which is what housing price futures are suggesting.
Posted by: Charlie Stromeyer Jr at August 6, 2008 01:14 PM
"In particular, we show that recessions associated with credit crunches and house price busts are deeper and last longer than other recessions are."
BUT I THINK THAT THEY ARE MISSING THE MOST DETRIMENTAL SHOCK THESE DAYS, NAMELY THE OIL PRICE SHOCK!!!
SO: HOUSE PRICES BUST+EQUITY PRICES BUST+OIL PRICE SHOCK+CREDIT CRUNCH = ??? (only time will tell us)
Posted by: Anonymous at August 6, 2008 02:02 PM
Paper paper now online here.
Posted by: Menzie Chinn at August 6, 2008 02:50 PM
It really makes one wonder what the catalyst for recovery would be. With much of the world economy reduced by 1.5% through 2011 and the dollar hitting limits for borrowing, there are painful adjustments ahead.
Posted by: Charles at August 6, 2008 03:12 PM
The charts and article extracts above don't mention the labor market. Maybe the full article does.
The recent rapid rise in unemployment, has only been seen in recessions. A useful chart on this phenomena is at http://www.hussmanfunds.com/wmc/wmc080805.htm
Posted by: Mike Laird at August 6, 2008 05:44 PM
The other shoe has yet to drop on housing. Within a year or 2, Asian & Petro-state central banks will be forced to quit buying US debt because of burgeoning inflation in their respective countries. The rate on the 10 yr Tres & hence on mortgages will increase substantially.
I suspect Calculated Risk has the housing recovery about right at 2013.
Posted by: algernon at August 6, 2008 08:58 PM
Charles- The catalysts for recovery are all around us... Repair or replacement of transportation infrastructure, build-out of renewable energy infastructure, rebuilding of city-center residential housing.
All these projects require capitalization, which will not occur until the excess leverage is purged out of the banking system and "players" take their losses. Algernon's comment regarding 2013 seems like a reasonable estimate for US housing recovery and credit market stabilization to begin.
Posted by: MarkS at August 7, 2008 08:09 AM
For those who have not yet read the paper that Professor Chinn refers to nor the paper by Professor Cecchetti that I referred to, I thought I would mention a contradiction between the two papers. Professor Cecchetti writes in his paper:
"Second, housing booms create future declines in output and increases in prices while equity booms do not. And third, the bigger the housing boom, the bigger the expected drop in output and the expected increase in the price level."
This risk of higher inflation after a housing boom contradicts what the paper that Professor Chinn refers to says about this particular point.
Posted by: Charlie Stromeyer Jr at August 7, 2008 11:44 AM
It is very odd, or coincidental that Bernanke is a big histroy buff of The Great Depression. I agree with Mark S, as to what the catalysts for recovery will be. Much like the WPA projects of the 1930's, but the added debt burden to the govetnment will take decades to recover those
"loans" to the economic stimuls projects, of alternative energy, and infrastructure. And much of the burden will be placed on the average tax payer.
Posted by: James E at August 7, 2008 01:21 PM
Concerning "The catalysts for recovery are all around us... ", the existence of unmet human needs is constant & isn't therefore critical to the creation of wealth. Resources have been grossly misallocated. The existence of problems to be solved does not erase that fact.
Posted by: algernon at August 7, 2008 04:59 PM
Charlie Stromeyer, do you define inflation as an "increase in the price level?"
Posted by: DickF at August 8, 2008 07:00 AM
DickF, to the best of my knowledge, all theories of economics define inflation as a rise in the general level of prices for goods and services over time. Note that there are 5 levels of "inflation" - deflation, disinflation, no inflation, inflation, hyperinflation - and what remains highly debatable are the causes of inflation:
Posted by: Charlie Stromeyer Jr at August 8, 2008 08:19 AM
This Chinn fellow is so full of (k)eynesian bs. But (thank God for humanity!) more and more renowned economists, such as Paul Kasriel et al., are beginning to take another look at the Austrian Theory of the Business Cycle. When will Chinn and his fellow keynesians will realize that what they are preaching (teaching?) is the modern equivalent of Ptolomeic science? Vive la liberté!!!! Long Live the Austrian School of Economics. http://blog.mises.org/archives/008304.asp (This is what Paul Kasriel had to say about the Austrian School, ha, ha)
Posted by: soros007 at August 8, 2008 11:05 AM
soros007: Thank you for your insightful and constructive comments. I do wonder if you are reading the same post I wrote. The first part is a collection of stylized facts. The second part is a quote from people who I would not necessarily characterize as raving (k)eynesians. By the way, what does it mean to write Keynesian with a small "k"? Of course, if Greenlaw, Hatzius, Kashyap, and Shin fall into your (k)eynesian camp, then pretty much all the economists I know fall into that camp.
Posted by: Menzie Chinn at August 8, 2008 11:31 AM
For myself I've never understood the attraction of the Austrians, they assert that the value of a good is based on its ability to satisfy a need, or utility.
Yet for a capitalist the only use of a good is its ability to yield a value above the cost of the inputs that were required to produce it. In other words its exchange value, not its use value.
They don't actually use the goods they produce. Hence if the utility of a good is irrelevent to the seller - if only the price matters to them - clearly its utility cannot determine its price.
In fact from my reading of Marshall and Jevons (admittedly English not Austrians) they conceded that in fact the price of production determined value not utility. Which rather makes you wonder why they bothered in the first place.
Sorry for the digression.
Posted by: bill j at August 8, 2008 12:12 PM
You should have read Carl Menger, not Marshall and Jevons. It is the subjective value that one attaches to the final product that determines the value of the factors of production (e.g. labor). Say, if Cuban cigars were to suddenly go out of fashion, the demand for that specialized labor would go down as well (and its implied value as well). Marx got it backwards because he bought Petty's argument of the labor theory of value. Which you also seem to do.
Posted by: Anonymous at August 8, 2008 02:25 PM
Anonymous (2:25 PM): You're responding to the wrong person. For my part, I've not read Menger, and do not plan to. I have read Varian (the graduate version). Nor have I cited the labor theory of value. I'm a marginalist, so that puts me in the neoclassical camp, as I understand the typology of schools.
Posted by: Menzie Chinn at August 8, 2008 03:26 PM
The question about the drivers of the recovery is extremely important and without attempt to answer it predictions looks like something build on quick sand. Can infrastructure and alternative energy projects became such a driver ? They probably cannot without further significant deterioration of standards of living. $4 gas is too low price for a dramatic shift of priorities of "affluent society". And convesion of car fleet into smaller hybrids probably does not mean new prosperity for car makers.
But if the perspective of recovery are postponed till 2012 that means that we might be now in the eye of the storm and some dramatic events wait us ahead.
Posted by: kievite at August 8, 2008 07:13 PM
Professor Chinn, actually marginalsim can be interpreted via either neoclassical or Austrian schools because marginalism was originally founded by Jevons, Menger and Walras:
For my own part, I believe in whatever seems to actually work! For example, the *only* paper which has ever shown that supply side tax cuts can actually work does so via a New Keynesian DSGE model:
Thus, I am willing to consider both the Austrian business cycle theory and New Keynesian models.
Posted by: Charlie Stromeyer Jr at August 9, 2008 04:32 AM
Well indeed yes, I'm not a marginalist and I do agree with Marx.
The subjective value that one attaches to a product, depends on how much money one has - capitalism does not recognise demand per se - but only effective demand.
The amount of demand one has in turn depends on the relations of distribution, which was why Ricardo wrote "To determine the laws which regulate this distribution, is the principal problem in Political Economy", but of course the laws of distribution rest on the laws of production, which is why the laws of production determine the value of a product or its price.
As in spite of themselves, both Jevons and Marshall conceded.
Posted by: bill j at August 9, 2008 05:13 AM
Whoa, James: "existence of unmet human needs is constant".
Can I point out that's a very socio-centric comment? Maybe you could qualify that as "in our winner-take-all, You're On Your Own current system, the existence of unmet human needs is constant."
I definitely agree "Resources have been grossly misallocated."
Posted by: Laurie at August 9, 2008 07:49 AM
Menzie, you'll notice that Laurie & many others are confused by listing the 'Posted by' under the line--confused as to who posted which post.
Posted by: algernon at August 9, 2008 08:25 PM
The housing bust may be shortened this time by the intervention of foreign wealth pools as petrodollars and war dollars come home to buy back US real estate. Perhaps the stock market decline will also be reversed as devaluing foreign held greenbacks come home to purchase equities.
Posted by: Broxburnboy at August 11, 2008 07:24 AM
Broxburnboy, this news article says you may be correct:
Posted by: Charlie Stromeyer Jr at August 11, 2008 07:43 AM