The evidence since 1880 shows a faster pace of recovery. The Obama years are the exception.
By MICHAEL BORDO
There's a belief among policy makers that serious recessions associated with financial crises are necessarily followed by slow recoveries—like the one we've experienced since mid-2009. But this widespread belief is mistaken. To the contrary, U.S. business cycles going back more than a century show that deep recessions accompanied by financial crises are almost always followed by rapid recoveries.The mistaken view comes largely from the 2009 book "This Time Is Different," by economists Carmen Reinhart and Kenneth Rogoff, and other studies based on the experience of several countries in recent decades. The problem with these studies is that they lump together countries with diverse institutions, financial structures and economic policies. They also conflate two different measures of speed—how long it takes a country to get back to its previous business-cycle peak, and how fast the economy grows once the recovery has started.
Milton Friedman had a different way of looking at recoveries from cyclical downturns: the "plucking" model. Friedman imagined the U.S. economy as a string attached to an upward sloping board, with the board representing the underlying long-run growth rate. A recession, in this view, was a downward pluck on the string; the recovery was when the string snapped back. The greater the pluck, the faster the bounce back to trend.
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As
Friedman wrote in 1964, "A large contraction in output tends to be
followed on the average by a large business expansion; a mild
contraction, by a mild expansion."
In a recent working paper for the National Bureau of Economic Research, Joseph Haubrich of the Federal Reserve Bank of Cleveland and I examined U.S. business cycles from 1880 to the present. Our study not only confirms Friedman's plucking model but also shows that deep recessions associated with financial crises recover at a faster pace than deep recessions without them.
We measured the depth of a contraction by the percentage drop in quarterly real gross domestic product from peak to trough. We measured the strength of the recovery in several ways: first as the percentage change in quarterly GDP in the first four quarters after the trough, then also looking further into the expansion. So, for example, since the 1920 recession lasted six quarters, we looked six quarters into the subsequent expansion.
We found that recessions that were tied to financial crises and were 1% deeper than average have historically led to growth that is 1.5% stronger than average. This pattern holds even when we account for various measures of financial stress, such as the quality spread between safe U.S. Treasury bonds and BAA corporate bonds and bank loans.
By contrast, the Reinhart/Rogoff analysis focuses on how long it takes the economy to return to its precrisis output level. Since contractions related to financial crises are generally deeper and longer than other recessions, they are followed by recoveries that take longer than normal to see output return: Since 1887, the growth of real GDP over both the recession and the recovery was 1.2% in recessions with financial crises and 2.2% in those without.
But that says little about how fast the economy grows once the recovery starts. As we found, since the 1880s, the average annual growth rate of real GDP during recoveries from financial-crisis recessions was 8%, while the growth rate from nonfinancial-crisis recessions was 6.9%.
Two cases underlying the averages were the financial-crisis recession of 1907-08 (which led to the founding of the Federal Reserve) and the infamous nonfinancial-crisis recession of 1937-38. In 1907-08, the recession drop in GDP was 12% and the recovery was 13%—perfectly consistent with Friedman's plucking model. In 1937-38 the drop was 13% and the recovery 7%.
Thus the slow recovery that we are experiencing from the recession that ended in July 2009 is an exception to the historical pattern. This can largely be attributed to the unprecedented housing bust, a proximate measure of which is the collapse of residential investment, which still is far below its historic pattern during recoveries. Another problem may be uncertainty over changes in fiscal and regulatory policy, or over structural change in the economy.
The legacy of the unprecedented housing bust calls into question whether in the future, expansionary monetary policy could make recoveries more consistent with the depth of recessions. Expansionary monetary policy in the past three years seems to have had only limited traction in stimulating the economy and speeding housing recovery. To catalyze full recovery in housing, we may need policies other than looser monetary policy.
Mr. Bordo is a professor of economics at Rutgers University and a fellow at Stanford's Hoover Institution.
In a recent working paper for the National Bureau of Economic Research, Joseph Haubrich of the Federal Reserve Bank of Cleveland and I examined U.S. business cycles from 1880 to the present. Our study not only confirms Friedman's plucking model but also shows that deep recessions associated with financial crises recover at a faster pace than deep recessions without them.
We measured the depth of a contraction by the percentage drop in quarterly real gross domestic product from peak to trough. We measured the strength of the recovery in several ways: first as the percentage change in quarterly GDP in the first four quarters after the trough, then also looking further into the expansion. So, for example, since the 1920 recession lasted six quarters, we looked six quarters into the subsequent expansion.
We found that recessions that were tied to financial crises and were 1% deeper than average have historically led to growth that is 1.5% stronger than average. This pattern holds even when we account for various measures of financial stress, such as the quality spread between safe U.S. Treasury bonds and BAA corporate bonds and bank loans.
By contrast, the Reinhart/Rogoff analysis focuses on how long it takes the economy to return to its precrisis output level. Since contractions related to financial crises are generally deeper and longer than other recessions, they are followed by recoveries that take longer than normal to see output return: Since 1887, the growth of real GDP over both the recession and the recovery was 1.2% in recessions with financial crises and 2.2% in those without.
But that says little about how fast the economy grows once the recovery starts. As we found, since the 1880s, the average annual growth rate of real GDP during recoveries from financial-crisis recessions was 8%, while the growth rate from nonfinancial-crisis recessions was 6.9%.
Two cases underlying the averages were the financial-crisis recession of 1907-08 (which led to the founding of the Federal Reserve) and the infamous nonfinancial-crisis recession of 1937-38. In 1907-08, the recession drop in GDP was 12% and the recovery was 13%—perfectly consistent with Friedman's plucking model. In 1937-38 the drop was 13% and the recovery 7%.
Thus the slow recovery that we are experiencing from the recession that ended in July 2009 is an exception to the historical pattern. This can largely be attributed to the unprecedented housing bust, a proximate measure of which is the collapse of residential investment, which still is far below its historic pattern during recoveries. Another problem may be uncertainty over changes in fiscal and regulatory policy, or over structural change in the economy.
The legacy of the unprecedented housing bust calls into question whether in the future, expansionary monetary policy could make recoveries more consistent with the depth of recessions. Expansionary monetary policy in the past three years seems to have had only limited traction in stimulating the economy and speeding housing recovery. To catalyze full recovery in housing, we may need policies other than looser monetary policy.
Mr. Bordo is a professor of economics at Rutgers University and a fellow at Stanford's Hoover Institution.
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