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Will we ever recover from the financial crisis?


Well, define recovery. If recovery is getting back to the low unemployment levels that preceded the crisis, then no, we might not ever recover. If recovery is just getting back to some more normal-looking growth and job numbers, it's still going to take a very long time.

That, at least, is the conclusion of a new paper from Carmen and Vincent Reinhart assessing the aftermath of severe financial crises and shocks. The two scholars looked at "real GDP (levels and growth rates), unemployment, inflation, bank credit, and real estate prices in a twenty one-year window" surrounding "the 1929 stock market crash, the 1973 oil shock, the 2007 U.S. subprime collapse and fifteen severe post-World War II financial crises." Their conclusion? Settle in. This may take a while.

Real per capita GDP growth, they found, is significantly lower in the decade following a financial crisis than in the decade preceding one. If we're just looking the global crises, the median GDP growth for an advanced economy in the 10 years before the Great Depression was 3 percent a year, and before the 1973 oil shock, 4 percent a year. In the 10 years after both crises, growth averaged 1.8 percent.

And it's the same story for other indicators: Unemployment remains high, with the pre-crisis average being 2.7 percent, and the post-crisis average sitting at 7.5 percent. "In ten of the fifteen post-crisis episodes, unemployment has never fallen back to its pre-crisis level, not in the decade that followed nor through end-2009." Housing prices tend to be depressed for years, and credit deleveraging takes about seven years (the graph atop this post compares pre-crisis credit booms and post-crisis deleveraging in a variety of economies). "There is little good news to be found," conclude the Reinharts.

It would be nice to believe that we'll be different, but their data are worrying here, too. The run-up to the 2007 financial crisis looked like the run-up to previous financial crises. It wasn't much bigger or smaller, or much faster or slower. If anything set it apart, it's that it was global in nature, where most crises afflict only one country, or one region. That our crisis is global makes recovery more difficult, as it gives us fewer healthy economies to sell things to.

In fact, the paper is depressing enough that the authors offer less in the way of policy advice than psychological coping strategies. "Recent discussions about the 'new normal' in reference to the post-crisis landscape leave the impression that the pre-crisis environment was 'normal,' " they write. "In fact, there are reasons to believe that the pre-crisis decade set a high-water mark distorted by a variety of forces." Matt Yglesias read their study and saw evidence that governments tend to do too little stimulus after financial crises, but that's about it for policy implications. The fact that everyone has done pretty badly after financial crisis implies that we've not quite figured out how to handle them. Anyone got a more optimistic take?

By Ezra Klein  |  August 31, 2010; 5:25 PM ET
Categories:  Economic Policy  
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Will we ever recover? Probably not in my lifetime. Probably not in my kids' lifetime!The democrats have convinced me about Hope and Change... Never again!

Posted by: dmax1 | September 1, 2010 8:40 AM | Report abuse

I've got a less-optimistic take: in previous crises -- especially the Depression -- the aftermath of the crisis was accompanied by serious reduction in income inequality. In the current "recovery", top-end compensation and corporate profits are booming, but median wages are flat and the long-term unemployed get nothing at all.

So in effect this time around we're basing our recovery hopes on the profligate spending of hedge fund managers and CEOs.

Posted by: paul314 | September 1, 2010 9:29 AM | Report abuse

"Will we ever recover from the financial crisis?"


Posted by: janye1 | September 1, 2010 10:39 AM | Report abuse

"Will we ever recover from the financial crisis?"


Posted by: janye1 | September 1, 2010 10:40 AM | Report abuse

Dear Ezra, a monetarily sovereign government (like the US, UK, Japan, Canada, and Australia) that is monopoly provider of a nonconvertible floating rate currency is not financially constrained. Taxes do not fund its disbursements, and interest-bearing securities do not finance it, either. There is never a question of the government running out of money, or going bankrupt. That is just a nonsense under the present monetary system. Any restraints imposed on the system are political and can be removed at will.

As currency issuer, the federal government plays a complementary role to currency users (households, firms, and US states). It must provide the currency they use, and its must provide the right amount. It does this through fiscal policy.

What is the right amount? There is a an accounting identity that explains this complementarity. This is not economic theory; it is basic national accounting. The government balance, domestic balance, and external trade balance must equal zero. That means that if the trade balance does not offset, then when the public wants to save or deleverage (as now), government must run a deficit to accommodate this. Otherwise, there will be massive defaulting of private debt leading to a debt deflation driven depression.

Government can always correct any situation by running a large enough deficit to accommodate the public's desire to rebuild its balance sheets and to close the output gap, returning the economy to full employment without generating inflation. Inflation occurs when nominal aggregate demand (spending power) exceeds the capacity of the economy to meet it with supply, implying full capacity and full employment. Then, government can reduce excessive demand by curtailing discretionary spending and increasing taxes.

This is what is supposed to happen with the automatic stabilizers, and in a business cycle, this in usually about enough. But at the end of a long financial cycle, ii is not enough, and government must become proactive. For example, far from anticipating incipient inflation, the historically low long bond yield is indicating that the bond market is calling for deeper deficits. However, government stands paralyzed, hoping that the Fed can handle this. It should be obvious that monetary policy cannot at this juncture.

The choice now is liquidation and depression, which will happen if greater fiscal austerity is imposed, or Japanification if we stay the present course of inadequate deficits, relying on ineffective monetary policy.

Respectfully, Tom Hickey

Posted by: tjfxh | September 1, 2010 12:21 PM | Report abuse

Will we ever recover? Not with our current economic model ...

The problem with all the models is the role of fractional reserve banking ... It has been the role of the economist to build their models around fractional reserve private banking money and credit creation when in fact this model built on unsustainable geometric growth will not work past the tipping point of ever decreasing, ever more expensive resources.

The fractional reserve model worked well for colonization where large infrastructure and investment yielded much larger reward. We are beyond this paradigm and are now in the paradigm of scarcity where increasing amounts of capital are needed just to maintain existing supply. The perfect example is oil.

Going forward only an economic model based on sustainability will endure. Tying our money supply to ever increasing growth is a fool's errand but one which nearly all economists use as an unspoken premise of their models ... One must remember that Keynes lived in a paradigm of ever increasing, ever cheaper natural resources ... Those days are over ...

Posted by: mmckinl | September 1, 2010 6:15 PM | Report abuse

If America is to recover they must look at what the conditions were like when the recovery after WW2 happened, taxes were much higher when JFK lowered taxes, the top rate was almost 90% reducing that helped spur investment in manufacturing, technology and housing but when Bush lowered taxes below 40% there was no increased investment, he used deficit spending and lax lending laws to create a phony economy that led to the bubble and bust, Reagan's tax cuts for the rich did the same thing..remember the savings and loan crisis or 1987? tax policy has to help the lower and middle income earners, that creates sustainable growth plus America needs a plan, a goal, then give tax rebates to industry to spend money implementing the plan..what should the plan be? Get America off imported oil and get manufacturing jobs back in the country, low paying service type walmart jobs will not do it, build a bigger wind power industry, bigger solar industry, convert all homes to heat pumps for heating and cooling to get rid of the need for imported fuel, build this technology in America, use tax incentives to stimulate manufacturing and job creation, buy things made in America, when people have real jobs they can afford to buy homes and cars AND pay taxes, the wealthy in America have had an easy time under the bush tax policy's but it is bankrupting America..what is wrong with the wealthy paying their own way instead of passing debt on to the next generation, America used to be the worlds biggest CREDITOR nation now they are the biggest DEBTOR nation, this has to change or CHINA will be calling the shots in America someday

Posted by: 7trumpets | September 3, 2010 6:32 AM | Report abuse

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