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Sunday, February 10, 2008


reinhart/rogoff paper getting traction

calculated risk notes that this paper is getting quite a lot of notice in economic circles. the upshot is that the current financial crisis in the united states shares some important characteristics with the "big five" post-ww2 crises -- spain 1977, norway 1987, finland 1991, sweden 1991, and japan 1992.

The “Big Five” crises are all protracted large scale financial crises that are associated with major declines in economic performance for an extended period. Japan (1992), of course, is the start of the “lost decade,” although the others all left deep marks as well.

japan is the most familiar example -- with more than a decade of deleveraging from 1990 on, with zombie banks and cleanup costs well over 15% of gdp -- but a little looking around the internet gives more extensive context.

spain's banking crisis ran from 1977 to 1985, with losses equivalent to some 17% of gdp. 52 banks representing 20% of total system deposits were liquidated, rescued or nationalized.

in finland leading up to 1991, economic growth averaged 4.5% a year; in the three years following, the economy contracted by (-4.0%) a year. with the government eventually taking stakes in banks controlling 31% of national deposits, which cost 11% of gdp to rectify.

the crisis of norway from 1987 to 1993 saw the government take over the three major natioanl banks, controlling 85% of system assets. recapitalization costs tallied 8% of gdp.

sweden from 1991 to 1994 saw five of the largest six banks approach insolvency, with two (accounting for 22% of system assets) actually become insolvent and end up rescued in a government-backed bailout plan. recapitalization costs amounted to 4% of gdp.

but a lot remains open. the united states is far more financialized than any of these predecessors -- that is, finance, banking and trading account for a greater proportion of gdp than any of these comparables did at the times of their crises.

one can use purchasing-power-equivalent gdp data for all these crisis periods to contextualize the economic damage. as noted by reinhart/rogoff, "Growth momentum falls going into the typical crisis, and remains low for two years after. In the more severe “Big Five” cases, however, the growth shock is considerably larger and more prolonged than for the average."

  • sweden in the two years from 1991 to 1993 saw ppp gdp decline (-3.2%).
  • norway saw ppp gdp stagnate from 1987 to 1989, and the same measure grew just 10% over the five years 1987-1992 (1.9% per year) after having grown 22% in the preceding five years.
  • finland saw ppp gdp from 1990 to 1993 dive (-10.6%) or (-3.6%) per annum.
  • spain from 1978 to 1985 grew at a rate of just 1.7% annualized in ppp gdp terms.
  • japan between 1990 and 1999 grew at just 1.1%, with ppp gdp flat in 1993 and actually falling (-2.1%) from 1997 to 1999.

reinhart/rogoff note that asset bubbles in all these cases included real estate -- indeed, called runups in real housing prices one of the best leading indicators of financial crisis -- and one suspects that the dynamic approached by calculated risk eslewhere is a key part of the failures of these economies to recover quickly.

in each case, unemployment became a major concern. spain saw unemployment jump from the mid-single digits into the 20% range and eventually peak at 25% in the early 1990s. the rate of unemployment in the three nordic economies are shown here -- norway jumped from below 2% in 1987 to 6% in 1992; sweden from 2% in 1991 to 8% in 1993; finland from under 4% in 1990 to 18% in 1993. even in japan, where unemployment was kept low by structure, it peaked at 5.5% in 2003 -- three times the pre-crisis level -- and examinations of the heavy social cost of maintaining employment became common.

UPDATE: barry ritholtz at big picture, by way of discussing the reinhart/rogoff paper, was led to more information on norway 1987, including a timely chart of norwegian negative real interest rates in the early 1980s.

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