Unpleasant Synergies: Recessions, Credit Crunches and Housing Busts

by: Menzie Chinn

From the abstract of a new paper by Stijn Claessens, M. Ayhan Kose and Marco E. Terrones, entitled "What Happens During Recessions, Crunches and Busts?" (Available online here):

We provide a comprehensive empirical characterization of the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the 1960-2007 period. In particular, we analyze the implications of 122 recessions, 112 (28) credit contraction (crunch) episodes, 114 (28) episodes of house price declines (busts), 234 (58) episodes of equity price declines (busts) and their various overlaps in these countries over the sample period. We document a rich set of stylized facts about the behavior of key macroeconomic and financial variables during these various events. Our results indicate that interactions between macroeconomic and financial variables can play major roles in determining the severity and duration of a recession. In particular, we show that recessions associated with credit crunches and house price busts are deeper and last longer than other recessions are. In light of our findings, we examine the implications of recent macroeconomic and financial developments in the United States for the future path of its economy.

With respect to ongoing events in the United States, they write:

These comparisons suggest that, while the current slowdown may share some features with the onsets of typical U.S. and OECD recession, it is worse in some dimensions, particularly in terms of speed of credit contraction, drop in residential investment and decline in house prices. We therefore also compare the developments in credit and housing markets in the United States to date to those in the past episodes of credit contractions and house price declines. Tables 2B and 3B showed that such credit contraction (crunch) and house price decline (bust) episodes on average lasted 6 (10) and 8 (18) quarters, respectively. If these statistics, based on a large number of episodes, provide any guidance, they suggest that the adjustments of credit and housing markets in the United States are only in the early stages relative to historical norms and might still take a long time. The earlier episodes suggest that the process of adjustment in the United States might persist in the coming months with further difficulties in credit markets and drops in house prices. This could bode consequently poor for the path of overall output, which, as we showed, falls more in recessions associated with credit crunches and house price busts than in recessions without such events.

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Excerpt from Figure 9 from Claessens, Stijn and Terrones. The solid line denotes the current U.S. slowdown. The light solid line is median of all recessions in OECD countries (except the United States) while the dotted lines correspond to upper and lower quartiles of these recessions. The dashed line is the median of all U.S. recessions. Zero is the quarter after which a recession begins (peak in the level of output).
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Excerpt from Figure 9 (continued) from Claessens, Stijn and Terrones. The solid line denotes the current U.S. slowdown. The light solid line is median of all recessions in OECD countries (except the United States) while the dotted lines correspond to upper and lower quartiles of these recessions. The dashed line is the median of all U.S. recessions. Zero is the quarter after which a recession begins (peak in the level of output). Short-term interest rate is the change in the level.

What this tells me is that while we might be seeing the bottom of the housing decline, it will likely take a long time for us to crawl out of this housing trough. (Personally, I'm not too confident about the conclusion that we have hit the bottom).

The preceding takes current observations on the U.S. experience, and places them against the average of preceding events. What does this say about the prospects for the U.S. economy? Peter Hooper, Thomas Mayer, and Torsten Slok undertake an analysis, similar to that conducted in the Greenlaw, Hatzius, Kashyap, Shin study discussed in this post, and write in the July 28 issue of Deutsche Bank's Global Economic Perspectives (not online):

The need for a reduction of the level of leverage of financial institutions and its potential implications for the economy at large has been the subject of a controversial discussion. In a paper titled "Leveraged losses" presented at the conference of the US Monetary Policy Forum [MPF] in February 2008 the authors estimate that the de-leveraging of US financial institutions would lead to a reduction of credit to US non-levered entities by about USD1 trillion (4.4% of the total assets of the US financial sector) and shave about 1.3 percentage points off GDP growth over the year following the negative credit shock (in addition to the effects from other transmission channels). A number of public commentators have found these numbers hard to believe and several economists have criticised the study on methodological grounds. In the following we use more recent data for analyzing the size of the de-leveraging and a slightly different method to assess its implications. Our analysis suggests a substantially larger cut-back in the credit supply than estimated by the MPF paper (14.5% of assets in the US). ... Using a different methodology to estimate the effect of the credit tightening on US GDP growth, we find that the negative effects will play out over a considerable period, shaving about 1.5 percentage points off US GDP growth (and something approaching that amount off euro area growth) over the next three years.

 

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