Deep Concern About the Economy: Three Views

The minutes of last month’s Federal Open Market Committee showed that there is deep concern about the economy among the members. That concern was not confined to just a downturn in the economy but also to a debilitating period of disinflation.

Over the past several days, several other economists have come forth with fairly dire warnings about the likely depth and length of the recession. One particular report that struck me was from Kenneth Rogoff of Harvard and Carmen Reinhart of the University of Maryland. They narrowed their study of recessions to those which derived from financial crisis and came up with some interesting observations. Among them:

They find that unemployment rises by 7 percentage points on average after a severe financial crisis and doesn’t peak until four years after the crisis. The jobless right bottomed at 4.4% last year. If history is a guide, it could rise above 11% by 2011.

They find that housing downturns last six years — meaning a recovery is still about three years away. Moreover, stock-price declines last three and a half years and total 55%. That would put the Dow Jones Industrial Average below 6500 before this is done. Moreover, government debt reaches 86% of gross domestic product –- or $12 trillion. This last data point on government debt is particularly sobering. Despite all of the hope that policy makers are putting on fiscal stimulus, it’s not like it hasn’t been tried before.

Their paper is refreshing because they do throw out a lot of caveats as to what makes the U.S. different, which is a tribute to their intellectual honesty. The study they present is sobering and no more than a guide, but I think when you take it together with the Fed minutes a picture of a pretty sick economy is evident.

more: here NY Times on Fed minutes, here actual FOMC minutes, here Rogoff and Reinhards paper

Comments

[PROXIMO:]

Excellent article. Thanks for the historical context.

Jan 07 01:35 PM

[Tony Petroski:]

Housing downturns "last 6 years." I've been around more than 50 years and I don't remember a housing downturn. Is the data pulled from the Roman Empire period?

Jan 07 07:12 PM

[Tom Lindmark:]

Tony,

I assume you are excepting the current housing downturn. I think it does qualify.

Actually the data is based on recessions caused by financial crises as opposed to other factors. As I mentioned, they do include a number of caveats. Worth reading the whole study.

Tom

Jan 07 11:07 PM

[John Lounsbury:]

Tony - - -

There have been recent housing down-turns. They just have not been as deep and as universal across the entire country. There were housing down-turns in the 1970's, from 1989 to 1994 and a more minor one from 2000 - 2003. The last was more localized to technology centers, reflecting the bursting dot.com bubble.

If you have been living in areas that escaped the previous downturns you have been fortunate. I lived in the northeast for all the previous bubbles cited and estimate that my residence lost 12%, 25% and 10%, respectively in each of the previous downturns.

Jan 08 02:09 PM

[axelrod608:]

First, the comparables are from other countries. Second, the unit of measurement used in the study is "average". This is not a statistical - or statistically significant - study. It offers a window thru which to view how other financially generated recessions have progressed and worked out.

Past American recessions have started from other causes, so if we base our expectations of how this one will progress and work out, we are comparing apples to oranges.

I'm surprised this study did not mention the study done by economists at the World Bank. They looked at all financial crashes over a thirty year period. One of their conclusions was that the length and depth of the following recession was directly proportional to the amount of money the government poured in attempting t fix the problem.

Based on the amount of money our government is pouring into this one, we should be prepared for the deepest, longest recession in history.

Jan 08 06:46 PM

[SeekingTruth:]

Thanks again , John Lounsbury, I was going to highlight those previous downturns also, for those still living in a "Roman Empire" time zone , but would not have done as well as you presented.
When home mortgage rates hit 10% in the early seventies, the home buying/selling market shut down completely. The real estate people , who were doing well up to then, were forced to abandon their jobs and seek other employment, etc.-- It was awful for everyone!, and I remember the other periods as well. Good work, John, thanks again.

Jan 09 05:27 PM

[John Lounsbury:]

axelrod - - -

You wrote: "I'm surprised this study did not mention the study done by economists at the World Bank. They looked at all financial crashes over a thirty year period. One of their conclusions was that the length and depth of the following recession was directly proportional to the amount of money the government poured in attempting t fix the problem."

I have read about this reference but have never read the source document. I have always wondered whether the world bank tried to attribute cause and effect. Did the amount of government money increase the recession or did the length and depth of the recession increase the amount of government monet "poured in"?

If the World Bank merely reports the numbers but makes no attribution of cause and effect, somebody should try to tackle the job. As with many economic analyses, the big problem is there is no direct experimental control. That is, for every economic condition for which government takes action there is no identical situatrion where they didn't. The entire analysis becomes a series of "on this hand, but then on the other hand". In spite of my (cynical) comment, this question deserves careful consideration. We may avoid some errors of commission and errors of ommission in the present crisis if there is some clarification.

Jan 09 07:54 PM