Carmen Reinhart: After the Fall, NBER 082710

After the Fall

Carmen M. Reinhart and Vincent R. ReinhartAugust 2010

JEL E6, F3, and N0

ABSTRACT

This paper examines the behavior of real GDP (levels and growth rates),unemployment, inflation, bank credit, and real estate prices in a twenty one-year windowsurrounding selected adverse global and country-specific shocks or events. The episodesinclude the 1929 stock market crash, the 1973 oil shock, the 2007 U.S. subprime collapseand fifteen severe post-World War II financial crises. The focus is not on the immediateantecedents and aftermath of these events but on longer horizons that compare decadesrather than years. While evidence of lost decades, as in the depression of the 1930s,1980s Latin America and 1990s Japan are not ubiquitous, GDP growth and housingprices are significantly lower and unemployment higher in the ten-year windowfollowing the crisis when compared to the decade that preceded it. Inflation is lower after1929 and in the post-financial crisis decade episodes but notoriously higher after the oilshock. We present evidence that the decade of relative prosperity prior to the fall wasimportantly fueled by an expansion in credit and rising leverage that spans about 10years; it is followed by a lengthy period of retrenchment that most often only begins afterthe crisis and lasts almost as long as the credit surge.Carmen M. ReinhartDepartment of EconomicsUniversity of Maryland4115D Tydings HallCollege Park, Maryland 20742;email:creinhar@umd.edu;and NBERVincent R. ReinhartAmerican Enterprise Institute1150 17

th

Street, NWWashington ,DC 20036Email:vincent.reinhart@aei.org

1

I.

Introduction

1

Three years have elapsed since the troubles in the United States subprimemortgage market erupted in the summer of 2007. In the interim, a global panicdeveloped and, just as normalcy began to return this year, concerns about a Greek defaultand widespread contagion in Europe shook the confidence of financial markets anew. Asthe dust has once again begun to settle, policymakers and financial market participantshave begun to ponder the economic effects of these adverse shocks beyond theirimmediate and evident costs.Critical to those considerations are the intermediate- and longer-term effects of severe economic dislocations, which potentially matter for spending behavior, aggregatesupply growth, asset pricing, fiscal budget prospects, and inflation determination. Toshed light on these matters, this paper examines the behavior of real GDP (both levelsand growth rates), unemployment, inflation, bank credit, and real estate prices in atwenty-one-year window surrounding various adverse global and country-specificshocks.The events of the past three years are not without precedent. However, thoseprecedents are spread across countries and over time. Two features, in particular, appearto have made the global economic contraction more virulent. First, financialintermediation was dealt a body blow. Financial institutions slashed new lending, andsome markets were seriously impaired for a time. Second, the declines in output were

1

This paper was prepared for the Federal Reserve Bank of Kansas City Jackson Hole Symposium,

Macroeconomic Challenges: The Decade Ahead,

August 26-28, 2010. We appreciate the comments of Craig Hakkio, Ken Rogoff, Bill White and conference participants. The views expressed, of course, are ourown. Correspondence:creinhar@umd.edu(Carmen Reinhart) andVincent.Reinhart@aei.org(Vincent Reinhart).

2synchronous across many countries. Virtually every country reporting export valuesposted significant drops in the fourth quarter of 2008, and fully one-half of 182 countriesrecorded outright declines in real GDP in 2009.

2

To capture both aspects, we examine fifteen severe post-World War II financialcrises in advanced and emerging economies and three synchronous global contractions,the Great Contraction after the 1929 stock market crash, the 1973 oil shock, and the 2007U.S. subprime collapse.Our main results can be summarized as follows:Real per capita GDP

growth rates

are significantly lower during the

decade

following severe financial crises and the synchronous world-wide shocks. The median

post-financial

crisis GDP growth decline in advanced economies is about 1 percent.

3

What singles out the Great Depression, however, is not a sustained slowdown ingrowth (which was smaller than that after the 1973 oil shock) as much as a massive initialoutput decline. In about half of the advanced economies in our sample, the level of realGDP remained below the 1929 pre-crisis level from 1930 to 1939.

4

During the first threeyears following the 2007 U.S. subprime crisis (2008-2010), median real per capita GDPincome

levels

for

all

the advanced economies is about 2 percent lower than it was in2007; this is comparable to the median output declines in the first three years after thefifteen severe post World War II financial crises. However, 82 percent of theobservations for per capita GDP during 2008 to 2010 remain

below or equal

to the 2007

2

See the first table in Reinhart and Reinhart (2009) for a century-long perspective on exports around crises.

3

The five advanced economy crises are: Spain (1977), Norway (1987), Finland (1991), Sweden (1991),and Japan (1992).

4

See the discussion in chapter 14 of Reinhart and Rogoff (2009). The advanced economy group for the1929 and 1973 comparisons is comprised of Australia, Austria, Belgium, Canada, Denmark, Finland,France, Germany, Greece, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Spain,Sweden, Switzerland, United Kingdom, and the United States. The 2007 analysis also includes Iceland.