Nicholas Oulton and María Sebastiá-Barriel Report That Hysteresis Effects of Financial Crises Are Large
Since an average financial crisis is associated with an increase in the output gap of about 5% points of GDP, the Oulton and Sebastia-Barriel finding that each year of ongoing financial crisis leads to a 1% point permanent fall in labor productivity gives us an η coefficient of 0.2 in the model of DeLong and Summers (2012).
- a real government borrowing rate r;
- a multiplier μ;
- a ‘hysteresis’ parameter η;
- a marginal tax share τ; and
- a ‘hysteresis shadow’ decay parameter ρ;
expansionary fiscal policy is self-inancing in a present value sense as long as:
μτ(η/(r + ρ) + 1) > 1
For μ=1.5 and τ=0.33, expansionary fiscal policy is self-financing in a present value sense as long as:
η/(ρ + r) > 1
With an η of 0.2, expansionary fiscal policy is self-financing as long as (ρ + r) < 0.2. The sum of the rate at which the hysteresis effects decay and the real interest rate on government debt have to add up to more than 20%/year for fiscal expansion to increase the long-run net burden of the debt.
That is a very easy hurdle to surmount right now.
Of course, in normal times with μ small and close to zero, expansionary fiscal policy is not self-financing.
Nicholas Oulton and María Sebastiá-Barriel: Long and short-term effects of the financial crisis on labour productivity, capital and output:
The behaviour of labour productivity in the United Kingdom since the onset of the recession in early 2008 constitutes a puzzle. Over four years after the recession began labour productivity is still below its previous peak level. This paper considers the hypothesis that economic capacity can be permanently damaged by financial crises. A model which allows a financial crisis to have both a short-run effect on the growth rate of labour productivity and a long-run effect on its level is estimated on a panel of 61 countries over 1955–2010. The main finding is that a banking crisis as defined by Reinhart and Rogoff on average reduces the short-run growth rate of labour productivity by between 0.6% and 0.7% per year and the long-run level by between 0.84% and 1.1% (depending on the method of estimation), for each year that the crisis lasts. A banking crisis also reduces the long-run level of capital per worker by an average of about 1%. The corresponding effect on GDP per capita is about double the effect on GDP per worker since there is a long-run, negative effect on the employment ratio.