October 22, 2012

APPLES AREN'T ORANGES:

Sorry, U.S. Recoveries Really Aren't Different (Carmen M. Reinhart and Kenneth S. Rogoff Oct 15, 2012, Bloomberg)

Why is our interpretation of the data so different than those of these recent commentators? Is the U.S. different?

Part of the confusion may be attributed to a failure to distinguish systemic financial crises from more minor ones and from regular business cycles. A systemic financial crisis affects a large share of a country's financial system. Such occurrences are quite distinct from events that clearly fall short of a full-blown systemic meltdown, and are referred to in the academic literature as "borderline" crises.

The distinction between a systemic and a borderline event is well established by widely accepted criteria long used by many scholars, and detailed in our 2009 book.
Indeed, in our initial published study on this topic, in 2008, we showed that systemic financial crises across advanced economies had far more serious economic consequences than borderline ones. Our paper, written nine months before the collapse of Lehman Brothers Holdings Inc. in September 2008, showed that by 2007, the U.S. already displayed many of the crucial recurring precursors of a systemic financial crisis: a real estate bubble, high levels of debt, chronically large current-account deficits and signs of slowing economic activity.

Today, there can be little doubt that the U.S. has experienced a systemic crisis -- in fact, its first since the Great Depression. Before that, notable systemic post-Civil War financial crises occurred in 1873, 1893 and 1907.

It is also important to define how a recovery is measured, and how success is defined. The recent op-eds focus on GDP growth immediately after the trough (usually four quarters). For a normal recession, the restoration of positive growth is typically a signal event. In a V-shaped recovery, the old peak level of GDP is quickly reached, and the economy returns to trend within a year or two.

Our book examined both levels and rates of change of per capita GDP; recovery is defined by the time it takes for per capita GDP to return to its pre-crisis peak level. For post- World War II systemic crises, it took about four and a half years to regain lost ground; in 14 Great Depression episodes around the world (including the U.S.) it took 10 years on average. A focus on levels, rather than percentages, is a more robust way to capture the trajectory of an economy where the recovery is more U- or L-shaped than V-shaped.
It also is a way to avoid exaggerating the strength of the recovery when a deep recession is followed by a large cumulative decline in the level GDP. An 8 percent decline followed by an 8 percent increase doesn't bring the economy back to its starting point.

Taylor, for example, appears to show the recovery from the Great Depression as the strongest in U.S. history, even though it took about a decade to reach the same level of per capita income as at its starting point in 1929.

Working with long historical series, we have stressed per- capita measures because U.S. population growth has fallen from 2 percent a year in the late 1800s to less than 1 percent in more recent times. Put differently, in the early 1900s, a year with 2 percent real GDP growth left the average person's income unchanged; in the modern context, 2 percent annual GDP growth means an increase of slightly more than 1 percent in real income per person. The impact of cumulative population growth even within an individual crisis episode is significant, as the recovery process usually spans four to 10 years.

Even allowing for all the above doesn't seem to entirely account for the differences between our interpretation and the conclusions of the Hassett-Hubbard, Bordo and Taylor op-eds.

Take the Panic of 1907, which fits the standard criteria of a systemic crisis (and one with a global dimension at that). We certainly would count that one. The narrative in the Bordo- Haubrich paper emphasizes that "the 1907-1908 recession was followed by vigorous recovery." Yet, as we show below, the level of real GDP per capita in the U.S. didn't return to its pre- crisis peak of 1906 until 1912. Is that a vigorous recovery? The unemployment rate (which we routinely include in our comparisons but the Bordo-Haubrich study doesn't consider) was 1.7 percent in 1906, climbed to 8 percent in 1908, and didn't return to the pre-crisis low until 1918.

The aftermath of the systemic banking crisis of 1893 is worse than the period after the 1907 episode, and the Depression of the 1930s is worse still. According to our 2009 metrics, the aftermath of the most recent U.S. financial crisis has been quite typical of systemic financial crises around the globe in the postwar era. If one really wants to focus just on U.S. systemic financial crises, then the recent recovery looks positively brisk. [...] 

So how many years did it take for per-capita GDP to return to its peak at the onset of the crisis? For the 1873 and 1893 (peak is 1892) crises, it was five years; for the Panic of 1907 (peak is 1906), it was six years; for the Depression, it took 11 years. In output per capita timelines, at least, it is difficult to argue that "the U.S. is different." It can hardly be said to have enjoyed vigorous output per capita recoveries from past systemic financial crises.

The notion that the U.S. exhibits rapid recovery from systemic financial crises doesn't emerge from the unemployment data, either. That data only begin in 1890, eliminating the 1873 crisis from the pool. [...]

The 2007 crisis is associated with significantly lower unemployment rates than both the Depression of the 1930s and the depression of the 1890s; it is more in line with the unemployment increases observed after the Panic of 1907.

It's remarkable how often analyses of the recent credit crunch conflate GDP with employment, even this one which begins by arguing that GDP per capita is the important indicator, but then switches to a focus on employment rates.  Let us consider only the question that the authors ask: So how many years did it take for per-capita GDP to return to its peak at the onset of the crisis? The answer--within a year from the trough--would seem to either dispel the notion that there was a systemic crisis or demonstrate that the crisis was met so effectively as to be sui generis.  Thanks, W.

Of course, the failure of employment to respond in similar fashion--even as GDP per capita surged back above pre-Recession levels--suggests that there is something wrong with those numbers.  The most obvious conclusion, though folks are reluctant to accept it, is that pre-Recession employment was artificially high and what we've been seeing is a market correction in employment.

Posted by at October 22, 2012 5:04 AM
  

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