Reinhart-Rogoff Find Hangovers in Bank Crises: Cutting Research

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Harvard University Professor Kenneth Rogoff. Close

Harvard University Professor Kenneth Rogoff.

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Photographer: Andrew Harrer/Bloomberg

Harvard University Professor Kenneth Rogoff.

It takes eight years on average for economies to regain the level of income lost in a banking crisis, and the U.S. and Germany are alone among 12 in having already done so since the 2008 turmoil, according to Harvard University professors Carmen Reinhart and Kenneth Rogoff.

Their study of 100 banking crises over two centuries, scheduled to be presented today at the conference of the American Economic Association in Philadelphia, found part of the costs of banking difficulties relate to how long it takes economies to recover.

Of the 12 economies examined since 2008, the per-capita gross domestic product of Greece, Italy, Netherlands, Portugal and Spain kept contracting through 2013, according to a draft of the paper. Other than the U.S. or Germany, the rest either didn’t grow or didn’t grow enough to attain their previous income peaks.

In 43 percent of the historical cases studied, economies double-dipped back into recession. The paper covered 63 crises in advanced economies and 37 in larger emerging markets.

“Speeding up recovery may require that advanced economy governments adopt some of the approaches that have been relegated to the emerging markets over the last few decades,” said Reinhart and Rogoff, who authored “This Time is Different: Eight Centuries of Financial Folly.”

Photographer: Jin Lee/Bloomberg

Harvard University Professor Carmen Reinhart. Close

Harvard University Professor Carmen Reinhart.

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Photographer: Jin Lee/Bloomberg

Harvard University Professor Carmen Reinhart.

Such policies include restructuring debt, allowing faster inflation and introducing capital controls.

“Delays in accepting that desperate times call for desperate measures keeps raising the odds that, as documented here, this crisis may in the end surpass in severity the depression of the 1930s in a large number of countries,” the economists said.

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The U.S. economy of 2013 resembled that of 1993 as companies and households move into a better position to spend, providing reason for optimism.

So says Joseph G. Carson, director of global economic research at AllianceBernstein LP. In both instances the nation was struggling to recover from recession, asset price declines, a banking crisis and excessive public and household spending.

While the current cycle is worse -- with average annual growth since 2009 a percentage point below the 2.3 percent of the 1990s -- going back in time points to better prospects for recovery, said Carson, a former economist at General Motors Co. (GM)

In mid-1993, for example, homebuilding was starting to recover and unemployment of 7 percent was on the decline. Households had put their finances back in order and businesses were beginning to spend. After a mild slowdown in 1995, the economy grew at or above 4 percent for the next four years.

“Many of the features that supported this rapid growth can be found in the U.S. economy today,” said Carson.

Unemployment is again 7 percent and consumers are spending now that household debt has fallen to what it was in the early 1990s. Homebuilding is picking up, as is business investment with companies such as The Boeing Co. (BA) and General Motors announcing intentions to spend more. Fiscal policy is being relaxed and monetary policy may not tighten as quickly as in the mid-1990s, allowing low interest rates to provide support.

The U.S. recovery has been slower this time than in the early 1990s. In 1991 the economy shrank just 0.1 percent before bouncing back the following year to spark the longest expansion on record, spawning the Internet bubble. This time around, output shrank in 2008 and by almost 3 percent in 2009 and has been sluggish since.

“We think there’s an increasing chance for the U.S. economy to duplicate the relatively fast growth of the mid-1990s,” said Carson in predicting expansion of between 3 percent and 4 percent for the next two to three years.

* * *

Politicians should be wary of trying to slow migration into their economies if they want to support growth.

A study, released last week and financed by the Economic and Social Research Council, looked at the case of the U.K. The coalition government’s senior party, the Conservatives, is seeking to reduce the level of net migration from hundreds of thousands to tens of thousands over time.

That amounts to cutting migration by more than half relative to the 200,000 per year anticipated by the Office for National Statistics over the next 50 years.

The study compared the ONS scenario and one in which net migration was reduced by 50 percent. The results showed that by 2060 the slower track left GDP lower by 11 percent and government spending 1.4 percentage points higher.

Reducing net migration “will have a strong negative impact on the U.K. economy,” said co-author Katerina Lisenkova, a senior research fellow at the National Institute of Economic and Social Research in London.

* * *

There was only a small change in the rankings of economies last year, according to the Centre for Economics and Business Research.

Russia overtook recession-struck Italy to secure eighth place in the top 20 economies by size, while Canada took 10th to pass India, which suffered from a decline in the rupee, the London-based research group said.

Outside the top ranks, Iran toppled to 30th from 21st and South Africa fell to 33rd from 28th as strikes and a weakening currency affect its position.

China remains on track to one day replace the U.S. as the largest economy, although the CEBR said its 2028 estimate is later than the prediction of many other economists.

* * *

The European Central Bank’s loose monetary policy is preventing the economy from stumbling into a 1930s-like circle of falling prices and contraction, according to a research note by Germany’s Bundesbank.

Deflationary pressures in the 1930s were caused by a sustained shrinkage of the economy, the Frankfurt-based central bank wrote. This caused consumers to expect falling prices over a longer period of time and prompted them to delay purchases, further harming already-contracting output.

“Today’s situation can hardly be compared with the one from the past because monetary policy is very expansive and thwarts the contraction,” the Bundesbank said. Prices and wages are falling in countries like Ireland and Greece not because of a deflationary spiral but because they were too high before the crisis, it argued in the note published on Dec. 19.

“Against this background, deflationary risks will remain very low,” the Bundesbank said.

To contact the reporters on this story: Simon Kennedy in London at skennedy4@bloomberg.net; Stefan Riecher in Frankfurt at sriecher@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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