Next Time Can Be Different—But It Probably Won’t Be

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In This Time is Different, their exhaustive history of banking crises, Carmen Reinhart and Kenneth Rogoff concluded that recessions caused by financial collapses are typically (a) really deep and (b) last a really long time. So it’s no surprise that the Great Recession has produced such a long stretch of sluggish growth. Historically speaking, though, Neil Irwin reports that Reinhart and Rogoff think the United States has recovered surprisingly strongly:

The short version of their conclusion: We’re doing pretty well! Or at least, pretty well by the standards of countries emerging from banking crises.

Of 100 systemic banking crises in the United States and around the world, Reinhart and Rogoff found that it takes an average of eight years for per-capita GDP to fully recover. Of the 12 countries directly hit by the global financial crisis that began in 2007, the United States and Germany have both returned to their pre-crisis levels of per-capita GDP.

….That all raises the question of “why”. Why is it that it takes so long for nations to recover from financial crisis-induced recessions? In an intriguing but not well-developed set of concluding observations, Reinhart and Rogoff argue that it is because advanced nations do not consider the kinds of radical actions that might deal with the heart of their financial problems: Restructuring debts so as to reduce the overhang that holds back growth in highly indebted countries, allowing higher inflation to achieve the same result, introducing capital controls.

This is the key to everything. Sure, a housing bubble that sets off a financial crisis is bound to produce a deep recession. There’s no way around that. But it’s possible to recover fairly quickly. It simply takes the will to understand what’s going on and the courage to implement policies that, in other circumstances, might seem reckless and foolhardy. We could have done that this time around, but we didn’t have the political courage to try it. Even worse, the Republican Party rather clearly lacked even the desire to rescue the economy once Barack Obama became president.

Can it be different next time? From a narrow economic standpoint, Reinhart and Rogoff think it can be. From a broader policy standpoint, it’s less clear. Political courage is in short supply these days.