Simple Proof That Strong Growth Has Typically Followed Financial Crises

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.”

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

Visit: John Taylor's Page, Blog

5 Comments on Simple Proof That Strong Growth Has Typically Followed Financial Crises

  1. 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. 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. 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. 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. 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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