I still say that anyone who really wants to win this thing had better speak out, and fast, and strongly, and directly with specifics --- about their plans for pulling the economy's bacon out of the fire.
In a study of historical credit crunches and housing busts, credit crises typically lasted 2.5 years with almost a 20% decline in real credit, while housing busts typically lasted 4.5 years with a 30% fall in real house prices.
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Tuesday, October 7, 2008
Lessons From Modern Economic Crises (Not for the Fainthearted)
nakedcapitalism.com
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Now that the world is in the throes of the mother of all financial messes, economists are scrambling to develop expertise. Carmine Reinhart and Kenneth Rogoff recently had this beat largely to themselves. but in the last two weeks, the IMF came out with a stud of 124 modern banking crises.
The latest addition to this growing body of knowledge comes from Stijn Claessens, M. Ayhan Kose,and Marco E. Terrones at VoxEU.
While we will excerpt the paper at greater length below, here is the key paragraph:
The episodes of credit crunches and housing busts are often long and deep. For example, a credit crunch episode typically lasts two and a half years and is associated with nearly a 20 percent decline in real credit. A housing bust tend to last even longer: four and a half years with a 30 percent fall in real house prices. And an equity price bust lasts some 10 quarters and when it is over, the real value of equities has dropped to half.
More from VoxEU:
The unique nature of the current financial crisis—combining a house price bust, a credit crunch, and an equity price bust—unlike any other one the US has experienced before, makes it difficult to assess its implications for the real economy. Barry Eichengreen recently assessed the lessons from the Great Depression (Vox 2008), but what of the evidence from modern times? However, around the world we have witnessed many such episodes of credit crunches and busts in house and equity prices. In fact, in recent work, we identified 28 credit crunches, 28 house price busts, 58 equity price busts, and 122 recessions in 21 advanced countries over 1960-2007 (Claessens, Kose and Terrones, 2008). These episodes provide some insights on how financial crises evolve and their implications for the broader economy....
How costly are recessions?
As shown in Figure 1, a recession on average lasts about 4 quarters (one year) with substantial variation across episodes — the shortest recession is 2 quarters and the longest 13 quarters. The typical decline in output from peak to trough, the recession’s amplitude, tends to be about 2 percent. For recessions, we also compute a measure of cumulative loss which combines information about both the duration and amplitude to proxy the overall cost of a recession. The cumulative loss of a recession is typically about 3 percent of GDP, but this number varies quite a bit across episodes. We classify a recession as a severe one when the peak-to-trough decline in output is in the top-quartile of all output declines during recessions. These recessions tend to be more than a quarter longer and much more costly than do typical recessions.
Crunches and busts: Often Long and Painful
The episodes of credit crunches and housing busts are often long and deep (Figure 2). For example, a credit crunch episode typically lasts two and a half years and is associated with nearly a 20 percent decline in real credit. A housing bust tend to last even longer: four and a half years with a 30 percent fall in real house prices. And an equity price bust lasts some 10 quarters and when it is over, the real value of equities has dropped to half.
Are recessions associated with crunches and busts worse than other recessions?
Contrary to the view of some commentators, the triple whammy of a house price bust, a credit crunch and an equity price bust has not always led to an eventual recession. What is true is that many recessions are indeed associated with credit crunches or asset price busts. In about one out of six recessions, there is also a credit crunch underway, and in about one out of four recessions a house price bust. Equity price busts overlap for about one-third of recession episodes. There can also be considerable lags between financial market disturbances and real activity. A recession, if one occurs, can start as late as four to five quarters after the onset of a credit crunch or a housing bust.
One of the key questions surrounding the current financial crisis is whether recessions associated with crunches and busts are worse than other recessions. Here, the international evidence is clear: these types of recessions are not just slightly longer on average, but also have much more output losses than others. In particular, although recessions accompanied with severe credit crunches or house price busts last only a quarter longer, they have typically result in output losses two to three times greater than recessions without such financial stresses. During recessions coinciding with financial stress, consumption and investment usually register much sharper declines leading to the more pronounced drops in overall output and unemployment.
Global nature of economic and financial cycles
For some, the global nature of the current crisis has been unprecedented as several advanced economies have simultaneously witnessed declines in house and equity prices as well as difficulties in their credit markets. However, this is not unusual as recessions, crunches and busts often occur at the same time across countries. Recessions in many advanced countries have been bunched in four periods over the past forty years—the mid-70s, the early 80s, the early 90s and the early-2000s—and have often coincided with global shocks. Moreover, when many countries experience a recession, many also go through episodes of credit contractions, declines in house and equity prices.
What are the lessons for the current episode?
The lessons from the earlier episodes of recessions, crunches and busts are sobering, suggesting that recessions, if they were to occur, would be more costly since they would take place alongside simultaneous credit crunches and asset price busts. Furthermore, although the effects of the current crisis have already been felt gradually around the world, its global dimensions are likely to intensify in the coming months.
The main take-away of the past episodes is that some tough times are ahead for the global economy before matters get better. Nevertheless, the nature of a recession in a particular country, if it happens, would ultimately depend on a number of factors, importantly how healthy the financial positions of its firms, banks, and households are prior to the recession, and what policies are being employed. This is high time for policy makers to act swiftly and decisively to undertake the necessary measures at both the national and global levels to meet the challenges of the crisis. |
