Saturday, November 29, 2014

This Recovery is Different

BRUSSELS – The misguided belief that “this time is different” led policymakers to permit the credit boom of the early 2000’s to continue for too long, thus preparing the ground for the biggest financial crisis in living memory. But now, when it comes to recovery, the belief that this time should not be different might be equally dangerous.

Many policymakers and economists have observed that the recovery from the 2007-2008 financial crisis has been much slower than most recoveries of the post-war era, which needed only a little more than a year, on average, to restore output and employment to their previous levels. By this standard, the current recovery is unacceptably slow, with both output and employment still below the previous peak. Policymakers thus feel justified in using all available macroeconomic levers to achieve a recovery that resembles those of the past.

In doing so, officials are reluctant to take into account that the recent crisis resulted from an unprecedented credit boom gone bust. To some extent, it should have been logical to expect an unprecedented upturn as well. When the crisis erupted, many hoped for a V-shaped recovery, notwithstanding a substantial body of research showing that recoveries from recessions caused by a financial crisis tend to be weaker and slower than recoveries from “normal” recessions.

The observation that recoveries following a financial crisis are different suggests that standard macroeconomic policies might not work as one would usually expect. And a transatlantic comparison suggests that this may indeed be the case.

One would expect that the shock from the financial crisis should be comparable for the United States and the eurozone, given that they are of similar size, exhibit a similar degree of internal diversity, and experienced a similar increase in house prices (on average) in the years preceding the bust. Moreover, the relative increase in debt (leverage) in the financial system was similar on both sides of the Atlantic.

And, indeed, US economic performance has been very similar to that of the eurozone since the start of the crisis: GDP per capita today is still about 2% below the 2007 level on both sides of the Atlantic. The unemployment rate in the US and the eurozone has increased by about the same amount as well – three percentage points.

Of course, one can point to particular countries in Europe that are mired in recession. But the US also has depressed areas. For Ireland and Spain, read Nevada and California (and, for Greece, read Puerto Rico). The proper comparison is thus between the average of two continental-sized economies, both of which are characterized by considerable internal diversity.

These similarities in economic performance are striking, given that macroeconomic policy in the US and the eurozone has been so different. The US let its fiscal deficit rise above 10% of GDP, compared to less than 6% of GDP in the eurozone. Measured over a five-year period (2007-2012), the US has thus not done any better than the eurozone, although it has relied on a much larger dose of fiscal expansion. In the US (and the United Kingdom), the general government deficit today is still around 8% of GDP, compared to a little more than 3% of GDP in the eurozone, and the US debt/GDP ratio has increased by more than 41 percentage points, compared to “only” 25 points in the eurozone.

In fact, the economy that has imbibed the strongest dose of expansionary policy has recovered less: GDP per capita in the UK today is still 6% below the 2007 level. Of course, one could argue that the UK was particularly exposed to the bust, because financial services make up a large part of its GDP. But the fact remains that its economy, supposedly the most flexible in Europe, has not recovered from the shock five years later, despite massive fiscal and monetary stimulus, coupled with a substantial devaluation.

On balance, it thus seems that this time – or, rather, this post-crisis environment – really is different, and that macroeconomic policies have done little to improve matters. Countries like the US and the UK, which are accumulating debt at a record pace, are betting that deficit spending will eventually pay off in a stronger economy. But they risk ending up with debt/GDP ratios north of 100%, which would leave them at the mercy of financial markets should sentiment turn against them.

History suggests that interest rates will not remain at record-low levels indefinitely, and that when change comes, it might be abrupt. Why should we expect this time to be different?

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    1. CommentedTom Fogarty

      It does appear that conventional policy measures have been relatively ineffective. Perhaps it's time hit control-alt-delete and reboot the system by attacking the root cause of the crisis: fractional reserve banking. The recent IMF paper "the Chicago Plan Revisited" suggests shifting the creation of credit from banks to government would, if proper honest money safeguards were in place, greatly reduce the risk of future credit boom/bust cycles. This would also create a seigniorage windfall which could wipeout government indebtedness and leave funds available to accelerate private de-levering as well. According to the authors estimates, such a reboot would also boost long term growth 10%. Of course it may be politically impossible to achieve such a radical change, it would certainly be bad for banking employment and force developed country labor to stop trying to unsustainably protect their standards of living from developing country wage competition.

    2. CommentedJohn Brian Shannon

      Hi Daniel,

      Appreciate your thoughtful post.

      I do think however that there are two kinds of deficit financing at work in the national economic picture of different nations.

      It could be argued that a dollar is a dollar is a dollar. And in one sense that is true.

      A dollar or euro added to a deficit has the effect of one dollar of spending power. We can just leave Ricard aside for this discussion and concentrate on the different effects of different deficit spending by governments.

      For example, if two identical economies suddenly were to add an extra 5% to the economy but spend it in different ways, I contend that very different results would ensue.

      In country A the decision is to continue to overspend and use the deficit to continue to afford unaffordable goods and services.

      In country B the decision is to hire many thousands of workers, that is unemployed people barely able to have discretionary spending (most unemployed would fall into this category) and put these people to work immediately.

      Both nations have the exact same economy, deficit and the same dollar amount of deficit increase at 5% of GDP.

      Which nation will receive the greatest amount of benefit? Which will boost it's GDP and thereby decrease it's debt-to-GDP ratio? And which nation will be more likely to keep it's prized credit rating.

      I think that there is no doubt that nation B will fare better in every respect, particularly five years on as the synergistic effects work their magic.

      Not only will unemployment rates drop dramatically, but unemployment insurance payments will lessen, the petty crime rate will lessen, policing costs in some areas will drop, food banks will get a reprieve and career-related spending will increase, which could mean anything from work-related clothing sales, tool and machine sales, education and instruction spending will also increase.

      People with jobs spend more money. A car is almost a necessity for many employed people, but when people become unemployed, car lots fill up with unsaleable cars.

      The qualitative approach to results-oriented deficit spending has been greatly overlooked.

      Nations could be spending the same, or less, but receiving much more bang for the buck, just by targeting the stimulus properly.

      To take it one step farther (although this then becomes a different argument) it could be said that 'regular deficit spending' (nation A) is not stimulus in any substantive way, but is merely paying for goods and services over time.

      While true stimulus, immediately begins to add employment to the economy (nation B) and thereby earns it's title. Stimulus of this kind, shows rapid results by lessening drag on the economy and adding new spenders, en masse.

      In a word, stimulus is NOT stimulus, unless it is *actually* stimulating the economy.

      Best regards, JBS

    3. CommentedKofi Jackson

      A shift to ordo-liberal policies is the solution. Create trust and structural diversity and make the whole of Europe converge towards the Swedish model.

    4. CommentedPaul Mathew Mathew

      What we are experiencing are the initial symptoms of the end of growth.

      Before fossil fuels and the industrial revolution economic and population growth were negligible.

      But in the past two centuries (and primarily the last century onwards) growth rates have resembled those of cancer cells.

      And now we are coming to the end of cheap energy - and make no mistake - there will be NO replacing fossil fuels.

      So as energy becomes more expensive it puts a drag on growth - so we borrow - we print - we do whatever because we must grow.

      But we will not.

      Unfortunately it is not possible to go back 200 years - we now have 7 billion people on this planet - a product of fossil fuels (the green revolution - pesticides and fertilizers - is a product of fossil fuels).

      We have in effect burned out the planet - soils are dead without fossil fuel-based fertilizers.

      I'll leave it to you to work out the consequences...

        CommentedJohn Brian Shannon

        Hi Paul Mathew,

        I agree that growth has hit a plateau in the Western, or as we say, developed economies, a process which has been at play since the 1970's.

        The same is not true when we talk about developing nations. Growth, and perhaps rapid growth will continue to be a factor there for a number of decades to come.

        The simplest demographics in the world tell us that the world's population will hit just under 10 billion by 2050. Not only that, the standard of living for almost everyone on the planet will dramatically improve.

        *Except for the 1 billion citizens of the developed world and until 2050, that number will remain a static one.*

        Western population numbers are not going anywhere exciting, whilst the developing world population will increase to almost 9 billion.

        We will not so much be outnumbered 10 to 1 by the developing nations, as they will be joining us as members of the developed world.

        Think of all that demand for goods and services worldwide -- much of it will occur simultaneously.

        It will be a great time to own a company which can export it's goods or services anywhere in the world. Educators especially may come to enjoy the new paradigm as real disposable income for individuals begins to affect developing nations.

        Here are two short TED lectures directly related to the topic. Slightly irreverent, but entertaining and informational.

        Best regards, JBS

    5. CommentedRoss Clem

      And what will happen to U.S. interest rates when its currency is no longer a safe haven? And what will happen to the U.S. deficit when it is necessary to pay a higher interest rate on its debt?

        CommentedJohn Brian Shannon

        Hi Ross Clem,

        Two very good questions.

        If it ever occurs that the U.S. currency is no longer a safe haven investment zone, America will spend itself dry to stay afloat. After that, insolvency.

        That may never occur, but if it does, it is at least 40 years away. There is still time to change the road you're on, America.

        As for your second question;

        Once interest rates rise, IF the U.S. economy is in a growth period, the credit rating will improve partially negating the costs of borrowing. Times of growth carry less risk for lenders and everyone relaxes their requirements.

        If the economy appears to be well-balanced at that time the extra interest payments will simply be absorbed without comment, nor concern.

        If the deficit has been pared down to a reasonable level and some amount of federal government debt paydown occurs (even token paydowns, in the absence of a large deficit) can re-energize the economy by lowering the debt-to-GDP ratio. This allows a country much more economic flexibility.

        John Maynard Keynes suggested that the time to pay down deficits is not during the bust, but during the boom times. If the U.S. government adheres to that line of thought and acts on it prudently as the economy improves over the next two decades, the great axe hanging over America's economy will simply cease to exist.

        Responsible government policy can solve the problem with ease. Otherwise, it will be curtains for the U.S. as a major economy.

        Canada has already gone through this process and succeeded spectacularly. See my post and embedded links at:

        Best regards, JBS

    6. Commentedjames durante

      Per earlier comments... growth IS the only way out. But growth will require an improvement in aggregate demand. All the hard core capitalists seem to provide two choices: either that demand will improve after everyone deleverages (by which time we may all be dead--whether because it will take so long or because of the economic shock) or the government must engage in various forms of increasingly desperate and relatively ineffective stimulus.

      At least one other option is that corporations voluntarily (through wage hikes) or involuntarily (through taxes) disperse some of the trillions of dollars of record profits they are currently holding. Wages have been stagnant or falling for middle and lower income workers for decades. Now we have the greatest income and wealth inequality that the US has seen since before the Great Depression. You can't get blood out of a turnip or demand from a population who had to turn their houses into ATM's to try to keep up.

      In the long run growth will probably kill us as we are running up against natural limits. In the short run...

    7. CommentedMark Pitts

      The author's stats speak loudly against the policies suggested by Krugman and others who promote the simple Keynesian model.

      As he shows, US & UK economies are in many ways doing no better than Euro economies, despite the much larger fiscal stimulus policies of the former.

    8. CommentedAnthony Juan Bautista

      The author's assertion of fact is debatable: "...notwithstanding a substantial body of research showing that recoveries from recessions caused by a financial crisis tend to be weaker and slower than recoveries from “normal” recessions."

      The Cleveland Fed asserts such recoveries are neither weaker nor slower:

      WP 12-14
      Deep Recessions, Fast Recoveries, and Financial Crises: Evidence from the American Record
      Michael D Bordo and Joseph G Haubrich
      Do steep recoveries follow deep recessions? Does it matter if a credit crunch or banking panic accompanies the recession? Moreover, does it matter if the recession is associated with a housing bust? We look at the American historical experience in an attempt to answer these questions. The answers depend on the definition of a financial crisis and on how much of the recovery is considered. But in general recessions associated with financial crises are generally followed by rapid recoveries. We find three exceptions to this pattern: the recovery from the Great Contraction in the 1930s; the recovery after the recession of the early 1990s and the present recovery. The present recovery is strikingly more tepid than the 1990s. One factor we consider that may explain some of the slowness of this recovery is the moribund nature of residential investment, a variable that is usually a key predictor of recessions and recoveries.

      Obama and Democratic Socialist pols want us to believe this recovery is different, harder, etc. It's not. It's just the mopping-up of misallocated capital, like all the rest...

        CommentedAnthony Juan Bautista

        Here in America, we've deployed $5 trillion of borrowed Keynesian stimulus in the past 3.5 years or so. And since 2008 the Fed has facilitated liquidity unprecedented in world history! There was an uncommon downturn, and uncommon remedies were introduced. And where are we? We are left arguing that a mystical counter-factual universe would have been worse. Perhaps true. But the reliable details are scientifically unknowable and partisan.

        Goosing AG to fill an output gap is fine, I guess. But Keynes didn't say run perpetual deficits, and then "stimulate" some more when the inevitable next recession hits. He did not say this at all.

        CommentedRock Steady

        Response to Anthony Juan Bautista: You say, "It's just the mopping-up of misallocated capital, like all the rest..."

        If this is the case, then would you not agree that if we are in a situation of excess savings (i.e., deficient aggregate demand) then "mopping-up" misallocated capital would not suffice? There is not enough demand for that misallocated capital to absorb all of the savings sloshing around the globe. In a roundabout way, you seem to be arguing for a Keynesian response.

        CommentedMark Pitts

        Although I certainly agree that policies in the last 4 years have made the recovery much weaker than it should have been, there is evidence that financial crises do have longer recovery periods. Take a look at Chapter 14 in "This Time is Different" by Reinhart & Rogoff. Their sample set is much larger than just the American record.

        More people should be studying the remarkable recovery in 1982, after a recession and monetary crisis that produced even higher unemployment that this recession. Why is it assumed that those policies would not work again today?

    9. CommentedJeremy Majerovitz

      Actually, that's a bold-faced lie. Euro Area economic performance has been much worse than US economic performance. Right now, the Euro Area has a -02% GDP growth rate, while the US has a +1.7% growth rate. The US has had generally falling unemployment recently, with unemployment now at 8.3%, while the Euro Area has had steadily increasing unemployment, now up to 11.3%. The fact is that the supposed "little known fact" that this entire article is based on (the idea that the Euro Area's economic performance has been about as good as the United States' performance) is not a fact at all. And of course, when the foundation of your argument is wrong, you know what happens to the rest of it. (Sources:

    10. CommentedJonathan Lam

      Gamesmith94134: This Recovery is Different

      Daniel Gros gave a few good points on the insidious harm that the overwhelming usage of the macro-economic that growth have became the poison to financial world; it is because the suppression on the deflation on the capital goods like housing and bloated price on the commodity good would cut profitability and the slow growth on the wages on labor and the investment from the retired; they just wore down the micro-economics that supply and demand are no longer relevant to the present development. Perhaps, the continuation on the quantitative easing on the financial would definitely make the implosion from the sustainability or austerity, further on, the polarization of rich and poor would much severe. Perhaps, we are standing on the turning point on the long recession or Japanification till we reckon with the creation of the another currency warfare as well the global trade war that we are at the mercy of the creditor and how their sentiments turn against us just like Mr. Gros said.

      Nature does have it way, everything can be substituted and contested through competitions. No matter how we suppress inflation or deflation, at present, it was the implosion on the micro-economics that sustainability or affordability were ignored; they are displaced through the sequences of macro-economic measures with that broke the rule of remedial process to make the wealth sustainable and goods affordable for the polity among nations. Anymore of the growth policy in the coming six months would be disastrous for the global financial and jeopardize the recovery permanently-----global Japanification to all.

      May the Buddha bless you?

    11. CommentedJonathan Lam

      Gamesmith94134: The death of inflation targeting

      It seems Mr. Jeffrey Frankel would had given a good insights monetary measures on the boom-bust cycle under the death of the inflation targeting, however, the term velocity shocks occurs after the money supply targeting as the aftermath of the non-circumvented crash made the economy vulnerable to reflation caused to break down the monetary system. Thus, reactions subjected to the exchange rates on currencies also created the flights of cash flow and credit crunch once the inflation or deflation is restrained and economical growth is compromised. Perhaps, it is how we criticize how ever-reacted the FED was if credit or investment were not responded sufficiently in case of disasters.

      As much of the CPI or GDP, they are just indexes to measure how vulnerable are we to the developments internally and externally. Perhaps, it is how Mr. Greensplan was proven to be wrong after the monetary easing, unfortunately, the coin is flipped in the death of inflation targeting. In term of the global financing or domestic growth, business cycle is under the pressure of the price and value, and the general public suits to the cost to the living. Since inflation and deflation is inclusively monitoring the sustainability in finance, the table turns when investments shift from macro-economical to micro-economical, and vice versa. Establishments abstains its vulnerability to profit, economy grows or falter, and we support the price through agreement of the value. Inflation or deflation became a mechanism for the protection in a way that price ameliorates to accommodate what we value. It is nature’s way or ecology of economics. Therefore, there is no miss in calculation. It is my belief that what is missing is only being substituted. Over-priced relatively to weaker income and under-valued relatively means strong dollar, they are just being replaced or displaced.

      I prefer if the FED or ECB can estimate both the margins of inflation and deflation under the currencies exchange rate or both long term and short term equitable creates the comfort zone for affordability for both of the debtors and creditors. Such zone becomes the margins of affordability which could affect how investors shift or retreat with their cash to advance their profitability, and how the public can support or defy on the value and expenditure in maintaining growth.

      But, each must be inbound with sustainable means or credit; eventually, there is lesser of surprise in the phrase of changing tables from micro-economic to its income earner, to macro-economic for the business cycle when credit or cash become the options to pivot point or velocity shock. Implosion and explosion are alike; they just shift as the coin is flipped.

      “Germany sold €4.56 billion in two year bonds at 0 coupon, suggesting investors are so afraid of the possible outcome of the sovereign debt crisis that they are willing to get no returns just for parking their cash in bunds.” By Forbes.

      Can inflation by 2% at the core for 30 years or two yea bonds at 0 coupon be guaranteed without consequence? It is not a question for disinflationary but Bundesbank or FED.

      May the Buddha bless you?

    12. CommentedRock Steady

      In my humble view, there is a lot of smoke and mirrors in this analysis. A significant number of economists would totally disagree with your characterization that current policies are "expansionary." Many would say that the "expansion" was insufficient, and that there was a lot of "stealth austerity," but let's assume your claim is substantiated and that expansionary policies worsen the debt ratio (specifically, the debt-to-GDP ratio). Just looking at mathematics, if GDP grows faster than debt, then that ratio would decrease or improve, correct? This improvement in debt-to-GDP would be viewed as a positive, no? So if the US, UK or eurozone were to undertake contractionary policies that induced a self-inflicted recession (e.g., the UK), isn't it possible, indeed likely, that GDP would go down faster than debt causing the ratio to worsen. Debt-servicing would become more difficult under these circumstances, no? It's just math. Why aren't more economists talking about growing our way out of this predicament when inflationary pressures are basically non-existent and interest rates can be raised from record lows?

        CommentedRock Steady

        To Anthony Juan Bautista, The problem with Japan in the 90's was slightly different, albeit with similarities to our current situation. One of the main issues holding back the "velocity of money," and therefore the "healing power" of expansionary fiscal policy, was an unhealthy banking system. Japan's banking system was not allocating capital effectively nor efficiently (the transmission mechanism was broken). And this is not to say the US, UK and eurozone don't have their own problems with their banks -- we most certainly do. Banking/financial reform is a key ingredient to creating sustainable growth, but we have not seen nearly enough movement in that regard. Still, this should not stop policy makers from supporting growth as a means of tackling high debt-to-GDP ratios.

        CommentedAnthony Juan Bautista

        Demographics special case aside, Japan tried to do the exact thing you're advocating. The Japanese 10-year hasn't yielded above 1% for 20 years I think, and GDP has averaged 1%. What does it matter if we become awash in low velocity money? This is not a path to prosperity.

        CommentedMark Pitts

        Growth is indeed the only answer. But here, I believe, are the reasons it doesn't happen.

        Growth policies requires many changes that entrenched special interests have the power to defeat.

        Growth requires de-regulation that much of the public opposes.

        Government borrowing usually ends up being spent on pet projects and consumption, not on the investment that would create future growth.

    13. CommentedZsolt Hermann

      From the article:
      "On balance, it thus seems that this time – or, rather, this post-crisis environment – really is different, and that macroeconomic policies have done little to improve matters."
      This is an understatement. The policies not only "done little", but every step, every "solution" deepened the crisis wasting resources on policies and institutions that have become obsolete.
      In order to understand how different this time is we could imagine going to sleep from this world one night and waking up on another planet the next day.
      Everything that we used yesterday, the "language", the attitude, all the tools and methods are totally useless because we are in a different reality.
      Of course this did not happen overnight, but we still haven't examined or understood the fundamental changes, and want to dream on that things can simply go on as before.
      First of all the world has become global and integral, with all the details and laws that those expressions contain. It means we are all chained into a single, unified network with each other, we all depend on each other 100%, thus the previous fragmented, isolated, individualistic or nationalistic world view not only does not fit, but it is actually harmful, like a cancer trying to eat its own tissue.
      Besides the constant quantitative growth economic model, which is based on an illusion that such system can exist and develop incessantly has exhausted itself, it has become unsustainable.
      It depleted both the natural and the human resources, and since it is based on overproducing goods nobody truly needs for normal life, and its lifeline is the perpetual debt taking, consumption like a giant Ponzi scheme, now as this process has slowed down and stopped in Europe in the US and is going to stop everywhere else the whole machinery is collapsing, and it is impossible to revive.
      Einstein said that it is impossible to solve problems with the same mindset they were created with, thus we need a different human being to solve the crisis.
      The global conditions, the natural system around us is not going to change, only we can change and build a completely new system with a new attitude adapted to our new reality.
      We have the talent, the ingenuity, adaptability, all we need is a psychological shift.

    14. CommentedVictor Stern

      The US was fighting a couple of wars during the same period, while Europe wasnt. That alone may explain the difference in deficits.

      As for lack of difference in effect, it a very interesting observation.