October 23, 2012
Guest Contribution: How “Different” is the Recovery from the Financial Crisis?
By David Papell and Ruxandra Prodan
The slow recovery from the financial crisis and recession of 2007 – 2009 has become a centerpiece of the Presidential election. In last Tuesday’s debate, Mitt Romney, picking up on a theme that has been emphasized by John Taylor, contrasted the current slow recovery with the much faster recovery from the 1981 – 1982 recession. During the past two weeks, there has been an intense focus on a comparison of the current recovery with recoveries from other financial crises. On October 11, Taylor, using historical data from a paper by Michael Bordo and Joseph Haubrich, argued that the current recovery is much slower than the average of previous American recessions associated with financial crises. This was followed by an October 14 paper by Carmen Reinhart and Ken Rogoff who argue that the aftermath of the U.S. financial crisis has been typical of the recoveries from other severe financial crises, an October 15 reply by Taylor, an October 16 rejoinder by Reinhart and Rogoff, an October 17 piece by Paul Krugman, and an October 17 reply by Taylor.
Last October, we presented a paper, “The Statistical Behavior of GDP after Financial Crises and Severe Recessions,” at the Federal Reserve Bank of Boston Conference on the “Long-Term Effects of the Great Recession,” and summarized the results in an Econbrowser post. The focus of the paper was to show that, while severe recessions associated with financial crises generally do not cause permanent reductions in potential GDP, the return takes much longer than the return following recessions not associated with financial crises. We focus on five slumps, extended periods of slow growth and high unemployment, following financial crises identified by Reinhart and Rogoff in their book, “This Time is Different,” that are of sufficient magnitude and duration to qualify as comparable to the current Great Slump for the U.S. - the slumps lasting 7 ¼ years for Denmark (1989), 7 ¾ years for Australia (1990), 8 ½ years for Finland (1990), 9 ½ years for Sweden (1990), and 12 years for the U.S. (1929), with the first year of the slump in parentheses. If the path of real GDP for the U.S. following the Great Recession is typical of these historical experiences, the Great Slump will last about 9 years but will not affect potential GDP. Assuming that the Great Slump started in 2007:4, it will not end until 2016:4. This scenario is consistent with recent Congressional Budget Office projections that the economy will remain below potential until 2018, but do not allow for changes in current law to avoid the “fiscal cliff” in 2013.
Assuming that history will repeat itself (on average) and the U.S. will return to potential GDP in 2016:Q4, we can ask whether the current recovery is typical of recoveries from other severe recessions associated with financial crises. Real GDP growth has averaged 2.2 percent over the 12 quarters between the trough of the Great Recession in 2009:Q2 and 2012:Q2, and will have to average 4.04 percent over the 18 quarters between 2012:Q2 and 2016:Q4 in order for potential GDP to be restored at that date. Since 12/30 = 0.40 and 18/30 = 0.60, we call the first 40 percent of the sample the first part of the recovery and the second 60 percent of the sample the second part of the recovery. The ratio of the growth rates of the second to the first part of the recovery will need to be 1.84 in order for potential GDP to be restored in 2016:4.
How does this scenario compare with historical experience? Figure 1 depicts the first and second part growth rates for Australia, Denmark, Finland, and Sweden, as well as the projections for the U.S. Table 1 provides more detail, including the growth ratios, the dates and duration of the slumps, and the trough and magnitude of the recessions in addition to the growth rates for the two parts of the recoveries. We do not include the U.S. during the Great Depression because the recovery was interrupted by the recession of 1938, making the ratio sensitive to the exact split. The growth rate ratios provide a better comparison than the first part growth rates because of differences in the magnitude of the recessions and the pre-recession growth of potential GDP. In one respect, the scenario for the U.S. is typical, as the growth rates for the second part of the recovery are larger than the growth rates for the first part of the recovery, so that the growth ratios are greater than one, for three of the four countries. In another respect, however, the U.S. scenario is atypical, as the required growth ratio of 1.84 is higher than three of the four growth ratios and is 48 percent higher than the average historical growth ratio of 1.24.
Much of the disagreement between Reinhart and Rogoff and Taylor comes from differences in their methodologies. Reinhart and Rogoff measure a recovery as the time it takes for per capita GDP to return to its pre-crisis peak level, while Taylor measures a recovery as the average growth rate of aggregate GDP in the first 4 or 8 quarters following the trough of the recession. Because we assume that U.S. GDP will return to potential according to the historical average and compare growth ratios for each country for the two parts of the recoveries (starting from the trough) rather than comparing growth rates across countries, we are subject to neither Reinhart and Rogoff’s criticism that Taylor’s methodology exaggerates the strength of the recovery following a deep recession nor Taylor’s criticism that Reinhart and Rogoff’s methodology mixes recessions with recoveries.
Reinhart and Rogoff and Taylor also disagree about the choice of financial crises. Taylor and Bordo argue that Reinhart and Rogoff lump together countries with diverse institutions, financial structures, and economic policies while Reinhart and Rogoff argue that Taylor fails to distinguish systematic financial crises from more minor ones and from regular business cycles. We start with all episodes characterized by Reinhart and Rogoff as either mild or severe financial crises in advanced economies, and then choose the ones for which there is statistical evidence of a fall in GDP, so we are choosing episodes for which there is evidence of both a financial crisis and a recession. Among the four crises, Australia and Denmark are characterized as mild and Finland and Sweden are characterized as severe by Reinhart and Rogoff. If we restrict the comparison to Finland and Sweden, for which the magnitude of the recession and the duration of the slump are more comparable to the actual magnitude and projected duration of the Great Slump for the U.S. than Australia and Denmark, the required growth ratio of 1.84 for the U.S. is higher than both growth ratios and is 82 percent higher than the average historical growth ratio of 1.01.
Using a different metric than either Reinhart and Rogoff or Taylor, we have provided evidence that the current recovery for the U.S. has been slower than the typical recovery from severe recessions associated with financial crises. In order for potential GDP to be restored in 2016:4, the growth rate will have to be 84 percent higher between 2012:2 and 2016:4 than it was between 2009:2 and 2012:2. While it is typical for growth to be higher during the second part of the recovery from severe recessions associated with financial crises, the magnitude of the necessary difference is well above the average historical experience.
This post by David Papell and Ruxandra Prodan
Posted by Menzie Chinn at October 23, 2012 08:00 AMdigg this | reddit
It's a lot of work when you end up looking at Finland and Sweden as though the experience of two countries, located next to each other and going through slumps at the same time, is universal.
I'm sorry but analysis like this reminds me there is too much math and not enough thought.
Posted by: jonathan at October 23, 2012 08:10 AM
The 1990 European recessions were not at all financial crises, but rather stemmed from the unique circumstances surrounding the fall of the Iron Curtain in 1989.
During the Communist Era, the companies in Eastern Europe (mostly SOEs) were insulated from competition and the region was closed to international trade. When the Wall came down, the region was suddenly exposed to the full force of western European competition, and these SOEs largely went bankrupt and were purchased by multinationals. I know: I valued a good number of them in Hungary at the time.
Thus, this period was consumed with a fundamental re-organization of competitive advantage in the region, affecting both Eastern and Western Europe. In Eastern Europe, SOEs collapsed and were privatized, generally to foreign strategics (at least in Hungary). In Western Europe, manufacturing migrated to lower cost Eastern Europe. VW acquired Skoda in the Czech Republic; Slovakia became a auto manufacturing powerhouse; Suzuki built a plant in Hungary; and the Audi TT would be assembled just near the Austrian border in Gyor. These jobs left Western Europe and migrated east, with a marked effect on Western European markets.
So, the collapse of Communism was emphatically not a financial crisis--although it did have financial implications. It is fair to say that it took seven years to recover--that's when Hungary turned the corner. But that's how long it took to rebuild the industrial base, not to pay down debts from a prior asset bubble.
Ruxandra should know that, as she was in Romania at the time (albeit still in school).
Posted by: Steven Kopits at October 23, 2012 09:07 AM
I would also like to highlight the difference, in oil terms, between 1983 and the current recovery.
After 1979, Saudi Arabia decided on a high oil price policy, which it defended by reducing production. So, in 1979, the Kingdom was producing about 10 mbpd (about the same as today). It raised the price to about a level equal to 9% of US GDP, and consumption began to plummet. This was the Second Oil shock associated with the 1980 and 1982 recessions (although on the graph it looks like a single recession).
By 1983, global oil consumption had fallen by 6 mbpd and Saudi production with it--to a mere 3 mbpd. Meanwhile, 7 mbpd of crude oil production capacity had been brought on line, primarily from the North Sea and Gulf of Mexico. Thus, the global economy in 1984 had 25% surplus production capacity for oil. This overhang would take a generation to consume--a generation commonly known as "The Great Moderation".
By contrast, the Great Recession did not see a lasting fall in oil consumption, which today is about 3 mbpd above where it was in the first half of 2008. Far from tanking demand, the Great Recession throttled it up as China and other non-OECD economies emerged from their years of Communist ideology and isolation (so this is still the Berlin Wall!).
Nor did high oil prices increase the oil supply materially. In 2011, crude oil production was only 350 kbpd above where it was in 2005. Today, surplus production capacity is probably all in Saudi Arabia, and many doubt that it exceeds 2 mbpd (assuming the Saudis were willing to deploy it). Eight years after the plateauing of the oil supply, we have practically no spare capacity to show for it. Contrast that to 25% spare capacity in just the four years to 1983!
Oil prices have not fallen below the carrying capacity of the US economy, as they did in 1983/1984. Instead, the remain above the OCED carrying capacity, and further US oil consumption declines look highly probable.
Therefore, this recovery does not look like the recovery after 1983; it looks like the oil shock of 1982. We are by far not out of the woods; nor does it appear we will be anytime soon.
Now, I understand that 62 economists at Foreign Policy don't think oil rates even a mention, but it's also true that not one of them has either the historical knowledge or analytical framework to have written this comment. It might not hurt if our Dabblers spent a little time with the data.
Posted by: Steven Kopits at October 23, 2012 09:54 AM
"We start with all episodes characterized by Reinhart and Rogoff as either mild or severe financial crises in advanced economies, and then choose the ones for which there is statistical evidence of a fall in GDP, so we are choosing episodes for which there is evidence of both a financial crisis and a recession."
I'm sorry but this description is not at all satisfactory.
For example Reinhart and Rogoff classified the 1991 Czech Republic banking crisis as "high income" and according to the Conference Board the Czech Republic suffered a large decline in real GDP in 1991.
I believe there are other milder cases classified as banking crises by Reinhart and Rogoff, that involved declines in real GDP on a quarterly basis, such as Norway in 1987 and Japan in 1992, that have also been totally ignored.
And what about earlier episodes? Reinhart and Rogoff list a total of 107 banking crises in high income countries since 1800. Many of these involved declines in real GDP, in particular the US Panics of 1873, 1893 and 1907.
There are clearly other criteria being used and they are not being spelled out.
Posted by: Mark A. Sadowski at October 23, 2012 10:24 AM
'...we are choosing episodes for which there is evidence of both a financial crisis and a recession. Among the four crises....'
Talk about doing violence to the 'rule of 30'.
Posted by: Patrick R. Sullivan at October 23, 2012 10:33 AM
Very interesting post. Thanks!
Given that your metric doesn't explicitly use cross-country data in computing the "pace of recovery" score, it immediately raises the question of how the U.S. recovery compares to other countries in today's cross section. That would perhaps give us a sense of how effective policy has been in the U.S. compared to what is possible in this crisis, although there are an awful lot of confounding variables.
Posted by: Robert Bell at October 23, 2012 11:29 AM
Steve Kopits: "The 1990 European recessions were not at all financial crises, but rather stemmed from the unique circumstances surrounding the fall of the Iron Curtain in 1989."
The issue is whether or not Sweden and Finland had a financial crisis at the time. Many may agree with your analysis of the importance of the Soviet economy's implosion in setting the stage for that crisis. (In the case of Sweden, the Riksbank's decision to raise overnight interest to 500% might also deserve some mention.) That does not preclude the possibility that there was a financial crisis; on the contrary, it adds supporting evidence. You might just as convincingly argue that there was no financial crisis in the US, just a housing market downturn.
Posted by: Simon van Norden at October 23, 2012 01:15 PM
David Papell: Thanks for this interesting analysis. As you would probably expect, I'm wondering how uncertainty about the estimated growth rate of potential output affects these results.
Could you give us some idea of how robust your conclusions are to reasonable alternative assumptions on those growth rates? (for example, a 1 std. dev. shock in one direction for the US and in the other direction for the other countries.)
Posted by: Simon van Norden at October 23, 2012 01:22 PM
The trouble is, this was not a severe recession at all. A Severe recession is 15% decline in GDP. This was more like 5-6%.
Since it wasn't a severe recession and a shorter recession than 79-83, it is close in recovery speed.
It may not go past the 80's expansion due to credit lags rathern than credit boom, but don't give me this poor analysis.
Posted by: The Rage at October 23, 2012 01:35 PM
I was in Hungary at the time, so I saw things first hand.
Finland had had a special relationship with the Soviet Union and it went down hard with it, as I recall. (This was pre-Nokia days.)
I don't remember Sweden.
Having said that, and having lived through the '79 recession(s), the collapse of Eastern Europe, and the Great Recession, I can appreciate similarities and differences.
The collapse of Eastern Europe post-1989 was very, very different from what we see now. Whole sectors were wiped out; frankly, most sectors were wiped out. Let's see. I worked on projects in steel, agriculture, health care, wine, porcelain, airlines, oil, power, publishing, banking, printing, petrochemicals--all these were overstaffed by a factor of 2-3 with old or non-competitive capital equipment, zero IT and minimal management competence. And Hungary went cold turkey--these changes came just about overnight. One day, Traubisoda owned the market; next day, they were going up against Coke and Pepsi.
Costs increased by multiples. For example, I recommended that Budapest triple its sewer fee--and they did, to western levels, raising prices for pensioners clearing $300 per month. Budapest water consumption fell by something like a third in a year.
I would do my prelimary cash flows in my head when I visited a manufacturing facility (typically pre-privatization). If the grass was uncut and the paint pealing on the buildings, that was OK. If some of the machines didn't work, that was pretty bad. If the roof was leaking, that was really bad, because it meant that didn't have enough money to protect the production equipment beneath it. And when the bathrooms had no toilet paper, well, that speaks for itself. So I could run my cashflows without really needing to see the books--just by visual inspection of the facilities. Or going to the bathroom.
I once did a project at a leading brewery--today owned by SAB. I visited with the CFO and he took out a stack of invoices. He said to me, "So Steven, let me show you how I do crisis liquidity planning. I take out this stack of invoices every day, and I figure out which ones I have to pay today in the hopes of keeping us operating. The rest I put back into my drawer until tomorrow." That's how tough the siutation was. (He was a good CFO.)
This is why the MDF (a center right Christian democratic party which won the first election) was voted into oblivion in the second free election.
But it wasn't a financial crisis. The brewery was completely uncompetitive. Then SAB came in, set norms for everything, invested in equipment, and made a ton of money. But that would be years later.
And these were the prestige jobs. My wife, who led a USAID project there on mass unemployment, got to visit the bauxite, uranium and lignite mines and the meat processing plants. You can imagine the layoffs there.
In any event, it was a huge mess. An entire generation was written off. Consider how North Korea would compete against South Korea if the border opened. It was like that.
But there were no run on banks; no speculative asset bubbles at the time. (There was nothing to speculate on.) No oil shock. Nothing Gorton-like. Just an economy completely unprepared to compete.
Posted by: Steven Kopits at October 23, 2012 02:35 PM
Unfortunately in economics, ideology may always be given a chance to trump empirical evidences.
Let us start with Pr Ramey paper, useful as not embroiled in a debate but a factual representation of a switch private debts to public debts, that occurs in the midst of financial crisis
Valerie A.. Ramey NBER paper « Government Spending and Private Activity » Multiple evidences of a switch from private expenditures to public expenditures,
leading to the built up of public debts and shown not to be driving a large multiplier in private sector economy.
Let us go to « What’s the damage Medium term output after crisis » IMF Dynamics after crisis. Empirical evidences as gathered from internal sources. Rarely countries experimenting financial crisis, banking crisis and bluntly sovereign debt crisis do return to their previous output. Sample surveyed 40 years and 88 banking crisis, coupled with a foray in the 19th Century.
BIS paper « The real effects of debts »
Not to forget B.Eichengreen and O Rourke paper as mentioned in the last reply of the contested empirical evidences
Carmen M. Reinhart and Kenneth S Rogoff « Sorry, U.S. Recoveries Really Aren’t Different »
Now few additions to the contest
Are the GDPs under survey sharing the same domain of definition, only recently the Federal Reserve has excluded food and energy from inflation consequently minimizing the GDP deflator. It may require to visit the orchard of comparison.
No mention is made when contesting Carmen M. Reinhart and Kenneth S. Rogoff study and conclusion, of the effects of debts and public debts where recoveries occur at the asymptote of the debts curves. That requires, dealing with two constraints and not only the debts themselves. Since dealing with anticipation it would be more thorough to address all constraints.
Often it is reproached to the micro economists not be so at ease with the macro functions. There has been no debts crisis, banking crisis where some of the commodities producers have not been in debts moratorium and debts profiles have not been modified.There has been no recoveries from a private sector enterprise,where additional debts were exclusively and continously allocated to operating expenses.
Posted by: ppcm at October 23, 2012 07:26 PM
My Hungary post yesterday brought back many memories.
The payments crisis in Hungary in 1990-1992 actually had a name. It was called "sorban allas", or waiting in line. That's how it was known generally in Hungary.
I recall now that I actually looked at a number of SOE financial statements at the time and modeled out a good number of these companies.
In essence, what happened was that the receivables of these companies went bad because the revenues of their customers fell into deep decline with entrants of foreign competitors into the market. Revenues at many of these SOEs fell by 40-80% in a few months.
As a result, they were rationing their supplier payments, and in turn, so were their suppliers--hence the sorban allas.
This occurred across the board. Suddenly, sheep farmers were facing imports of lamb from New Zealand and Australia; makers of detergent, shampoo and toothpaste were facing Unilever and Proctor & Gamble; makers of cars like the Skoda and Trabant were facing Volkswagen and Opel. Overnight.
But there was no asset bubble or banking crisis. This was a crisis of the real economy--financial issues were only following the collapse of the real events--just the opposite of the financial crisis in the US.
Most of the companies I valued in Hungary attained a value of zero, for three reasons. First, their products were uncompetitive; second, they were over-staffed and severance payments were material to the value of the company; and third--though this is little noted in the west--many of these companies had very significant environmental liabilities.
A couple of examples:
I valued a wheel manufacturer in Borsod, a town tucked in a narrow mountain valley in eastern Hungary. It's a poor place. They made wheels for Ikarusz buses (since gone under), but using a two-piece wheel which is not used in the west. Thus, their wheel-making technology had no future.
I stayed at the guest house there. As a foreigner, they tried to turn out their best for me, but it was pretty run down and all communist era stuff at that.
I took a bath in the guest house bath tub--the water reeked of sulfur. I did my day's work and returned to Budapest. After a couple of days, sores began to appear on my body and slowly to spread, as might a hole in a paper napkin burnt by the hot tip of a cigarette. I feared the sores would continue to grow and consume my skin. But after a while, they stabilized and healed.
I later realized that this was quite likely the result of the water I had bathed in in Borsod, right next to the wheel factory. And that was, I believe, the municipal water supply there.
On another occasion, I visited a chemicals distribution company located perhaps 10 miles north of Lake Balaton, the largest freshwater lake in Central Europe and a key recreational area and source of commercial fish in Hungary.
The CEO and I talked of the usual topics regarding products and operations, and the conversation turned to mercury. The company handled a good bit of mercury. Again, the facility was old, with cracks in the floor. I asked the CEO whether they ever lost any mercury. He said, well, probably a few kilos, it slipped through the floor, but it was probably in the ground just under the facility.
Mind you, this facility was in the Balaton watershed, only ten miles from the lake.
This was Hungary in the early 1990s.
Posted by: Steven Kopits at October 24, 2012 05:55 AM
Well, well. Scott Sumner weighs in on the economic contribution of oil production:
Though most sectors of the [UK] economy are suffering from weaker productivity growth, two stand out. One is North Sea oil and gas, where output per hour has dropped more than 40% in five years.
The other is financial services, where productivity was growing by more than 4% a year, but in the past three years has been falling nearly 3% annually, as its output has plunged. Just these two sectors provide much of the explanation for the very weak productivity numbers.
If oil and finance explain “much” of the productivity shortfall, then ipso facto they explain “much” of the RGDP shortfall.
Posted by: Steven Kopits at October 24, 2012 07:55 AM
Rogoff Reinhart are brilliant
but their goal was to find common persistent elements over the centuries and there they are,
their view can be consistent with extra new flaws in the modern system, that
1 derivatives and complex product and garbage valuations
2 modern fake financial ” insurance”
3 the asset backed securitization cycle and stalled recovery
were the particular and fixable parts of the last financial bubble. RR and Dalio are heroes of mine, the premier financial cycle theorists now eclipsing soros. Though all still building on Minsky 101.
Still, they still simplify to say these are just modern versions of a centuries old cycle of bank lending and financial asset and collateral overvaluations and bursts. In some ways that may be true,
but diagnostically i submit it would help going forward if it was understood in modern detail, why the last one happened and why no one wants to buy securitized products now? we havent even recognised and taken the losses yet? To the contrary the bailout and maintaining all the debt is completely new
it may also turn out that the nearly stalled US Europe recovery which is compleely inadquate is not strictly due to Rogoff malaise and and its expected 5 -7 year sluggishness.
if this turns into a completely premature new global recession way before any new financial or real cycle peak? even these five will have to go back and reformulate.
Posted by: AWH at October 24, 2012 07:58 AM
Moritz Schularick and Alan Taylor update their results regarding post-crisis growth rates, in a VoxEU post today.
Posted by: Menzie Chinn at October 24, 2012 10:06 AM
Now take oil and gas out of Taylor et al, and then what you do have? Scott Sumner.
Posted by: Steven Kopits at October 24, 2012 10:30 AM
This analysis misses one central point: Today, we are in the midst of a globally cointegrated financial depression, incomparable with the experience you report: small countries during periods when international finance was unperturbed. Today, as in the best 1930's papers, simultaneous national experiences require consideration.
Posted by: Ronald Calitri at October 28, 2012 01:04 PM
This analysis shares the same faults as the Taylor analysis. Because it only looks at the speed of the recovery from the trough, it ignores the fact that the key positive impact of the Obama (and Bush if you include the TARP) policies might have been to make the trough shallower. This is much more in keeping with how the policy was sold - "do this and avoid the Great Depression". We did avoid a new GD and did not experience a fall of 50% of nominal GDP and unemployment of 25%. Frankly I think Reinhardt and Rogoff are exactly right to look at the time it takes to regain per capita GDP as the better measure of how well policy avoided hardship.
Posted by: Eddie Allen at October 30, 2012 04:05 PM