Reinhart: "This is not something that policymakers can undo quickly."
In their book “This Time is Different,” Carmen Reinhart and Kenneth Rogoff construct the richest and most detailed history of financial crises that anyone has developed. Their data set covers 66 countries, five continents and eight centuries, and gives them an unparalleled ability to see patterns and predictors among different types of crashes. And see them they do. I spoke to Reinhart on Wednesday about the speed of the recovery, why financial crises are different from normal recessions and what, if anything, can be done. An edited transcript follows.
Ezra Klein: Why are the recessions after financial crises so much worse than normal recessions?
CR: The words credit and debt cannot be stressed enough.The period ahead of a severe financial crisis is a period in which you’re borrowing from the future, fueling current growth by building up debt. The private sector accumulates debt on the expectation that incomes and asset prices keep going up. But though it’s painless to accumulate debt, it’s painful to unwind it.
Your normal recession and recovery isn’t as intimately involved with this boom and bust in leverage. That is an extremely important difference between recoveries from financial crises and normal recoveries. It’s one thing to lose five pounds and another to have to lose 50. It’s the leverage that you build up.
EK: How long do the recoveries normally take? Are we performing about normally?
CR: The answer to your question depends on your benchmark. Compared to a normal recession, we’re going slowly. Compared to your normal financial crisis, we’re on track. The average post-war recession lasted less than a year. The last time we had a severe recession was 1982, and by the end of 1982, the economy was recovering in a rip-roaring manner.
EK: But that wasn’t a financial-crisis recession?
CR: Right. That’s why I say it depends on your benchmark. Compared to a normal recession, we’re subpar. Compared to a financial crisis, we’re not out of line.
EK: So then let’s focus on financial crises. How long does the recovery usually take?
CR: The recovery in housing and employment is much slower than in equity and GDP. The housing cycle’s peak-to-trough is about six years. In GDP, your peak-to-trough is about two years,and another two years to get back to where you were before the crisis. Peak-to-trough for employment to stabilize is about five years. Full recovery is even longer, and sometimes it doesn’t happen.
EK: You mention that equity has returned, which is part of corporate America’s recovery. So they’re sitting on a lot of money, and there’s a lot of confusion and frustration over the fact that they don’t seem to be hiring. Is this normal?
CR: It isn’t corporate, non-financial companies that are overleveraged. It’s the households and the financial industry. The corporates are not burdened down by all this debt overhang that I’ve been talking about. So it’s not surprising that the corporate sector is recovering sooner. But the households, which are their ultimate consumers, are still mired in debt. And so right now, you see a period in which corporations are being very cautious, and for good reason. There’s a lot of uncertainty about the engine of growth in the United States. In recent recessions, it was households. But now there are concerns about household’s abilities to pull that off. So we have concerns about household balance sheets and, because of deficits, future tax policy. Uncertainty is not the best friend of investment.
EK: There’s a lot of the discussion about what Washington should do, but you seem to be saying that this is just going to take time.
CR: That is certainly my view. It’s not that governments are powerless. The government has been a key player in preventing a catastrophic global shock. We didn’t end in a depression. I can’t stress that enough. It’s played already a much larger role in placing a much higher bottom. But we built up this debt not overnight, but over years. And now we expect the resolution to be very rapid. This is not something that policymakers can undo quickly. If you look at the big, historic panaroma, deleveraging takes time. It’s not pretty. It’s not the answer people want to hear, but these debt cycles are lengthy.
August 4, 2010; 5:57 PM ET
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