This draft from December 19, 2008 written by Carmen M. Reinhart University of Maryland and Kenneth S. Rogoff Harvard University krogoff@harvard.edu
The Paper was prepared for presentation at the American Economic Association meetings in San Francisco, Saturday, January 3, 2009 at 10:15 am. Session title: “International Aspects of
Financial Market Imperfections.”
The paper was sent to AgFood Think Tank by Cornell Phd Economist Dr. Enrique Kawamura e-mail: kawa@udesa.edu.ar website and after analyzing it we believe it will help our network to better understand the outputs of financial crises. The paper also helps understanding what can advanced economies possibly have in common with emerging markets when it comes to banking crises.
A year ago, we (Carmen M. Reinhart and Kenneth S. Rogoff, 2008a) presented a
historical analysis comparing the run-up to the 2007 U.S. subprime financial crisis with
the antecedents of other banking crises in advanced economies since World War II. We
showed that standard indicators for the United States, such as asset price inflation, rising
leverage, large sustained current account deficits, and a slowing trajectory of economic
growth, exhibited virtually all the signs of a country on the verge of a financial crisis—
indeed, a severe one. In this paper, we engage in a similar comparative historical analysis
that is focused on the aftermath of systemic banking crises.
In our earlier analysis, we deliberately excluded emerging market countries from the comparison set, in order not to appear to engage in hyperbole. After all, the United States is a highly sophisticated global financial center. Infact, as Reinhart and Rogoff (2008b) demonstrate, the antecedents and aftermath ofbanking crises in rich countries and emerging markets have a surprising amount in common. There are broadly similar patterns in housing and equity prices,unemployment, government revenues and debt. Furthermore, the frequency or incidence of crises does not differ much historically, even if comparisons are limited to the post–World War II period (provided the ongoing late-2000s global financial crisis is taken into account). Thus, this study of the aftermath of severe financial crises includes a number of recent emerging market cases to expand the relevant set of comparators.
Broadly speaking, financial crises are protracted affairs. More often than not, the
aftermath of severe financial crises share three characteristics. First, asset market
collapses are deep and prolonged. Real housing price declines average 35 percent
stretched out over six years, while equity price collapses average 55 percent over a
downturn of about three and a half years. Second, the aftermath of banking crises is
associated with profound declines in output and employment. The unemployment rate
rises an average of 7 percentage points over the down phase of the cycle, which lasts on
average over four years. Output falls (from peak to trough) an average of over 9 percent,
although the duration of the downturn, averaging roughly two years, is considerably
shorter than for unemployment. Third, the real value of government debt tends to
explode, rising an average of 86 percent in the major post–World War II episodes.
Interestingly, the main cause of debt explosions is not the widely cited costs of bailing
out and recapitalizing the banking system. Admittedly, bailout costs are difficult to
measure, and there is considerable divergence among estimates from competing studies.
But even upper-bound estimates pale next to actual measured rises in public debt. In
fact, the big drivers of debt increases are the inevitable collapse in tax revenues that
governments suffer in the wake of deep and prolonged output contractions, as well as
often ambitious countercyclical fiscal policies aimed at mitigating the downturn.
I. The Historical Comparison Group
Reinhart and Rogoff (2008a) included all the major postwar banking crises in the
developed world (a total of 18) and put particular emphasis on the ones dubbed “the big
five” (Spain 1977, Norway 1987, Finland, 1991, Sweden, 1991, and Japan, 1992). It is
now beyond contention that the present U.S. financial crisis is severe by any metric. As a
result, we now focus only on systemic financial crises, including the “big five” developed
economy crises plus a number of famous emerging market episodes: the 1997–1998
Asian crisis (Hong Kong, Indonesia, Malaysia, the Philippines, and Thailand); Colombia,
1998; and Argentina 2001. These are cases where we have all or most of the relevant
data that allows for thorough comparisons. Central to the analysis is historical housing
price data, which can be difficult to obtain and are critical for assessing the present
episode.1 We also include two earlier historical cases for which we have housing prices,
Norway in 1899 and the United States in 1929.
II. The Downturn after the Crisis: A Comparison of Depth and Duration
The cumulative decline in real housing prices from peak to trough averages 35.5 percent. The most severe real housing price declines were experienced by Finland, the Philippines, Colombia and Hong Kong. Their crashes were 50 to 60 percent, measured from peak to trough. The housing price decline experienced by the United States to date during the current episode (almost 28 percent according to the Case–Shiller index) is already more than twice that registered in the U.S. during the Great Depression.
In Reinhart and Rogoff (2008b), we look at financial crises in 66 countries over 200 years, emphasizing the broad parallels between emerging markets and developing counties, including for example the nearlyuniversal run-up in government debt.The historical average, which is shaded in black in the diagram, does not include the ongoing crises.
Notably, the duration of housing price declines is quite long-lived, averaging roughly six years. Even excluding the extraordinary experience of Japan (with its 17 consecutive years of price declines), the average remains over five years. The equity price declines that accompany banking crises are far steeper than are housing price declines, if somewhat shorter lived. The shorter duration of the downturn when compared with real estate prices is consistent with the observation that equity prices are far less inertial. The average historical decline in equity prices is 55.9 percent, with the downturn phase of the cycle lasting 3.4 years. Notably, during the current cycle, Iceland and Austria have already experienced peak-to-trough equity price declines far exceeding the average of the historical comparison group.
On average, unemployment rises for almost five years, with anincrease in the unemployment rate of about 7 percentage points. While none of the postwar episodes rivals the rise in unemployment of over 20 percentage points experienced by the United States during the Great Depression, the employment consequences of financial crises are nevertheless strikingly large in many cases.
It is interesting to note that when it comes to banking crises, the emerging
markets, particularly those in Asia, seem to do better in terms of unemployment than do
the advanced economies. While there are well-known data issues in comparing unemployment rates across countries, the relatively poor performance in advanced countries suggests the possibility that greater (downward) wage flexibility in emerging markets may help cushion employment during periods of severe economic distress. The gaps in the social safety net in emerging market economies, when compared to industrial ones, presumably also make workers more anxious to avoid becoming unemployed.
Cycles in real per capita GDP around banking crises. The average magnitude of the decline, at 9.3 percent, is stunning. Admittedly, for the post–World War II period, the declines in real GDP are smaller for advanced economies thanfor emerging market economies. A probable explanation for the more severecontractions in emerging market economies is that they are prone to abrupt reversals inthe availability of foreign credit. When foreign capital comes to a “sudden stop,” to usethe phrase coined by Guillermo Calvo, Alejandro Izquierdo, and Rudy Loo-Kung (2006),economic activity heads into a tailspin.
Compared to unemployment, the cycle from peak to trough in GDP is much shorter,
only two years. Presumably, this is partly because potential GDP growth is positive, and
we are measuring only absolute changes in income, not gaps relative to potential output.
Even so, the recessions surrounding financial crises have to be considered unusually long
compared to normal recessions that typically last less than a year. Indeed, multiyear
recessions typically only occur in economies that require deep restructuring, such as
Notably, widespread “underemployment” in many emerging markets is not captured in the official unemployment statistics.
The deterioration in government finances is striking, with an average debt rise of
over 86 percent. Reinhart and Rogoff (2008b), taking advantage of newly unearthed
historical data on domestic debt, show that this same buildup in government debt has
been a defining characteristic of the aftermath of banking crises for over a century. We
look at percentage increase in debt, rather than debt-to-GDP, because sometimes steep
output drops would complicate interpretation of debt–GDP ratios. As Reinhart and
Rogoff (2008b) note, the characteristic huge buildups in government debt are driven
mainly by sharp falloffs in tax revenue and, in many cases, big surges in government
spending to fight the recession. The much ballyhooed bank bailout costs are, in several
cases, only a relatively minor contributor to post–financial crisis debt burdens.
III. Concluding Remarks
An examination of the aftermath of severe financial crises shows deep and lasting
effects on asset prices, output and employment. Unemployment rises and housing price
declines extend out for five and six years, respectively. On the encouraging side, output
declines last only two years on average. Even recessions sparked by financial crises do
eventually end, albeit almost invariably accompanied by massive increases in
government debt.
How relevant are historical benchmarks for assessing the trajectory of the current
global financial crisis? On the one hand, the authorities today have arguably more
flexible monetary policy frameworks, thanks particularly to a less rigid global exchange
rate regime. Some central banks have already shown an aggressiveness to act that was
notably absent in the 1930s, or in the latter-day Japanese experience. On the other hand,
one would be wise not to push too far the conceit that we are smarter than our
predecessors. A few years back many people would have said that improvements in
financial engineering had done much to tame the business cycle and limit the risk of
financial contagion.
Since the onset of the current crisis, asset prices have tumbled in the United States
and elsewhere along the tracks lain down by historical precedent. The analysis of the
post-crisis outcomes in this paper for unemployment, output and government debt
provide sobering benchmark numbers for how the crisis will continue to unfold. Indeed,
these historical comparisons were based on episodes that, with the notable exception of
the Great Depression in the United States, were individual or regional in nature. The
global nature of the crisis will make it far more difficult for many countries to grow their way out through higher exports, or to smooth the consumption effects through foreign borrowing. In such circumstances, the recent lull in sovereign defaults is likely to come to an end. As Reinhart and Rogoff (2008b) highlight, defaults in emerging market
economies tend to rise sharply when many countries are simultaneously experiencing
domestic banking crises.
energy to cities and towns across this country. And we will put Americans to work making our homes and buildings more efficient so that we can save billions of dollars on our energy bills.
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