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Not a Normal Recession, Not a Normal Recovery

Carmen M. Reinhart and Kenneth S. Rogoff:

Five Years After Crisis, No Normal Recovery: The point that all recoveries are the same -- whether preceded by a financial crisis or not -- is argued in a recent Federal Reserve working paper by Greg Howard, Robert Martin and Beth Anne Wilson…. It is mystifying that they can make this claim almost five years after the subprime mortgage crisis erupted in the summer of 2007 and against a backdrop of an 8.3 percent unemployment rate (compared with 4.4 percent at the outset of the financial crisis)…. [T]he aftermaths of severe financial crises are characterized by long, deep recessions in which crucial indicators such as unemployment and housing prices take far longer to hit bottom than they would after a normal recession. And the bottom is much deeper. Studies by the International Monetary Fund concluded much the same.

We have suggested that the concepts of recession and recovery need to take on new meaning. After a normal recession (which for the average post-World War II experience in the U.S. lasted less than a year), the economy quickly snaps back…. After systemic financial crises, however, economies of the postwar era have needed an average of four and half years just to reach the same per capita gross domestic product they had when the crisis started….

There also is the interesting question of whether, after a deep financial crisis, an economy will ever fully reach its earlier trajectory for trend GDP, or whether some output capacity is lost forever. Researchers at the Organization for Economic Cooperation and Development found that the most likely scenario involves some permanent loss, though extrapolations over long time periods -- a decade or more -- are necessarily subject to a high degree of uncertainty….

We admit that this time is different in one important respect: The goal posts many analysts use to assess economic outcomes seem to shift from data point to data point. When we first identified that financial crises were associated with severe recessions, the rosy-scenario crowd responded that the Great Moderation had smoothed the business cycle. Recessions in the new era were short and shallow.

After the crushing contraction, a new metaphor held that the harder the fall, the more vigorous the bounce back. Nonetheless, what followed was an anemic recovery that has yet to pull per capita annual real GDP back to the level of 2008.

Now, the staff of the Fed hopes to shift the goal posts yet again. Their advice is to forget about the problems of the past few years and focus on the coming expansion that they forecast using their own idiosyncratic interpretation of business-cycle dynamics across 59 countries….

Is the U.S. on track to an ever brisker recovery in which the jobs numbers -- which have already turned from 100,000 to 200,000 a month -- start showing 300,000 or even 400,000 net new jobs a month?

Perhaps. We hope for good news at the end of the week when jobs numbers are released….

But considering the huge and rising debt levels in the U.S., and the very limited extent to which deleveraging has taken place in the household and government sectors, we would be pretty happy to see a few straight years of trend growth, even if that falls short of the V-shaped recovery that some see around the corner. It might happen, but the historical evidence is at best mixed.

On the point of whether the aftermath of financial crises plays out differently than normal recoveries, the evidence isn’t mixed at all…