Yes, Financial Crises Do Bring Hangovers
In an essay making the rounds this week, four prominent academic economists and former government officials argue that something needs to be done to accelerate the pace of what they call "the weakest economic expansion since World War II." Their recipe for speeding things up is lower taxes and less entitlement spending, and I'm not going to get into whether that's really such a good idea, in part because I imagine lots of other people will take up that argument and in part because I just don't know the answer.
But I was struck by the second paragraph of the piece, written by John F. Cogan, Glenn Hubbard, John B. Taylor and Kevin Warsh, 1 which goes like this:
We do not share the view that the recent period of weak economic growth was simply an inevitable result of the financial crisis. Economic recoveries tend to be stronger after deep recessions, and any residual headwinds from the crisis should have long been remedied had progrowth policies been adopted. Historically, some post-crisis periods are marked by lower economic growth, but we believe that the poor conduct of economic policy bears much of that burden.
The view that periods of weak economic growth tend to follow major financial crises rests heavily on the work of Harvard economists Carmen Reinhart and Kenneth Rogoff, who examined 100 systemic financial crises around the world since 1857 and found that, as they wrote in a 2014 paper:
a significant part of the costs of these crises lies in the protracted and halting nature of the recovery. On average it takes about eight years to reach the pre-crisis level of income; the median is about 6.5 years.
Anyway, after I wrote a column in March that relied heavily on Reinhart and Rogoff's research, the abovementioned John B. Taylor responded thusly:
Hmm, I thought when I saw that. There were financial crises of 1973 and 1981? Yes, there were a couple of prominent bank failures in the U.S. in the wake of the 1973-74 and 1981-82 recessions (Franklin National Bank in 1974 and Continental Illinois in 1984), but they certainly didn't cause those recessions. The 1990 recession did occur in the midst of the long-running U.S. savings and loan crisis, but a) it was followed by a really weak recovery and b) that crisis, however painful, was still nowhere near as dire as the global shock of 2008.
When I looked at the 2012 Wall Street Journal op-ed by Rutgers University economist Michael Bordo that Taylor linked to, and the paper by Bordo and Federal Reserve Bank of Cleveland economist Joseph G. Haubrich that the op-ed was based on, my puzzlement did not abate. Not only does the paper count as "financial crises" several downturns that are generally not remembered as major financial crises,
but it also treats epic financial crises in a way that strikes me as unhelpful. The recession that followed the Panic of 1893, for example, was indeed followed by eight quarters of relatively rapid recovery, as documented in the chart above. But then came another deep recession almost immediately after those eight quarters, at the beginning of 1896, and yet another, milder one in 1899. Nobody in the 1890s thought the aftereffects of 1893 were modest and brief. The recovery that followed the recession that started in 1929 (also in the above chart) was indeed quite impressive, but it didn't start until 1933, after almost four straight years of economic contraction, and that was followed by another serious recession in 1937. That's why they call it the Great Depression, people!
In sum, I find Reinhart-Rogoff much more convincing than Bordo-Haubrich. This doesn't mean that economic hangovers following financial crises are inevitable, or that Taylor et al. are necessarily wrong about policy choices slowing growth. But it does mean that Bordo came nowhere near "demolishing" the hangover theory, and it also may bear on the policy prescriptions for spurring growth. If you think that the financial crisis of 2008 and its aftermath weren't major factors in the economy's subsequent struggles -- as Cogan, Hubbard, Taylor and Warsh appear to do -- you may be missing something important.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Cogan is a Stanford University public policy professor and senior fellow at Stanford's Hoover Institution who served in several positions in the Reagan administration. Hubbard is dean of the Columbia Graduate School of Business and was chairman of the Council of Economic Advisers under George W. Bush (he's also a faithful Bloomberg View reader; hi, Glenn!). Taylor is a Stanford economist who served in both Bush administrations and the Ford administration. Warsh is a visiting fellow at Hoover and a lecturer at Stanford's business school, and served on the Federal Reserve Board from 2006 to 2011 and in the George W. Bush White House for several years before that. Hubbard, Taylor and Warsh have all been mentioned as possible successors to Janet Yellen as Fed chairman.
The 1882, 1913, 1973, 1981 and 1990 downturns are all counted by Bordo and Haubrich as recessions associated with financial crises, but fail to make Reinhart and Rogoff's cut. Reinhart and Rogoff, meanwhile, include the U.S. downturns starting in 1873 and 1920 in their list of financial crises, while Bordo and Haubrich do not.
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