Simple Proof That Strong Growth Has Typically Followed Financial Crises

By Oct 12, 2012, 7:35 AM Author's Blog  

People are looking for answers to why the economy is growing so slowly. Is the answer that economic growth is normally weak following deep recessions and financial crises, as, for example, Kenneth Arrow argued in the presidential election event with me this week at Stanford? Or is poor economic policy the answer, as I argued?

In my view the facts contradict the “deep recession cum financial crisis” answer, so I have focused my research on economic policy and have found that the answer lies there. The chart below illustrates these facts. It is derived from historical data reported in a paper by economic historians Michael Bordo of Rutgers and Joe Haubrich at the Cleveland Fed.

The bars show the growth rate in the first four quarters following all previous American recessions that are associated with financial crises, as identified by Bordo and Haubrich. The upper line shows the average growth rate in all those recoveries. The lower line shows the growth rate in the four quarters following the 2007-2009 recession. It is very clear that recessions with financial crises are normally followed by much more rapid recoveries than this current recovery. The current recovery not only started out weak, averaging 2.5% in the first year, it got weaker over time, declining to only 1.3% in the second quarter of this year.

Growth was nearly 4 times stronger an average in the past recoveries. The only recovery in this list in which growth was as weak as this one followed the 1990-91 recession, but that was from a very shallow recession with output declining only 1.1%, so growth did not need to get very high to catch up. (The chart would look very similar if instead of 4 quarters you use the length of the recession from peak to trough as Bordo and Haubrich also do).

With such obvious evidence, how can people come to different views? Usually they mix in experiences in other countries with different economies at different points in time, as for example Carmen Reinhart and Kenneth Rogoff have done in an often cited book. But this approach can lead to mistaken conclusions, as Bordo explained recently in the Wall Street Journal. As he put it, “The mistaken view comes largely from the 2009 book “This Time Is Different,” by economists Carmen Reinhart and Kenneth Rogoff, and other studies based on the experience of several countries in recent decades. The problem with these studies is that they lump together countries with diverse institutions, financial structures and economic policies.”

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  1. Brett Manning says:

    You seem to have a remarkably low threshold for the word ‘proof’. As a physicist (BSc) turned economist (PhD) things like this from such note worthy economist makes me serious question my life choices.

  2. Chuck Carlson says:

    1973 and 1981 were recessions brought on by the Fed’s tight money policy, not financial crises, so you are comparing apples and oranges like you accuse Rogoff & Rienhart of.

    Your claim that growth after the depression that began in 1929 is ridiculous. How stupid do you think your readers are?

  3. Barry says:

    Krugman disagrees:

    Money quotes: “The second is that Taylor is awfully free in designating recessions as the result of financial crisis. He counts 1973 and 1981 as financial crises, to which the only answer if you know your history is, what on earth is he talking about? These were both disinflation recessions, caused more or less deliberately by the Fed; the Fed pushed interest rates very high to calm prices, and a V-shaped recovery took place once the Fed decided we had suffered enough. This isn’t hindsight: the contrast between those kinds of recessions and the slump following the bursting of a housing bubble was the reason many of us predicted a long, slow recovery well in advance. (It’s been even slower than I predicted back then, but in early 2008 I didn’t realize how bad the debt overhang was).”

  4. JDFulmer says:

    As others have already noted, neither 1973 nor 1981 qualify as a fiscal crisis. With high degree of confidence, I contend Taylor is familiar with the details of both recessions. Therefore it seems likely their inclusion was designed to skew sampled data in favor of a particular political point.

  5. David says:

    This guy desperately wants to be named Chairman of the Fed. He thinks if he writes enough shady ‘proofs’ like this, Romney will get elected and definitely appoint him.


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