Earlier this week, the IMF released a key chapter from the upcoming World Economic Outlook: Chapter 4: What’s the Damage? Medium-Term Output Dynamics After Financial Crises. As noted in the much pithier summary, the report concludes that:
The global financial crisis is likely to leave long-lasting scars on the world economy, but governments can act to stimulate a quicker revival and counter output losses … . The study finds that banking crises typically have a long-lasting impact on the level of output, although growth eventually recovers. Lower employment, investment, and productivity all contribute to sustained output losses.
Those conclusions are based on their review of financial crises around the world since the early 1970s. As shown in the following graph, the key finding is that after a financial crisis economic output remains below trend for years:
The blue line shows, for example, that in the average country, output seven years after the crisis was about 10% below what would it would have been if the pre-crisis growth rate had continued.
The dotted red lines, however, highlight the enormous range of outcomes. At least one-quarter of the countries eventually had output that was above the level implied by the earlier trend; while another quarter eventually fell at least 25% below the prior trend.
The study slices and dices this result in numerous ways, trying to identify the factors that lead to better or worse outcomes. Some are bad news for the United States.
For example, countries with weak current account balances tended to do worse than average:
On the other hand, countries that are open to world capital markets did better than average:
Putting it all together, the IMF ends up quite cautious about growth prospects for nations recovering from the financial crisis, including the United States. That conclusion is consistent with similar findings by Carmen Reinhart and Ken Rogoff that I’ve discussed before.
Perhaps not surprisingly, the IMF also tries to end on a note of policy optimism:
The medium-run output loss is not inevitable. Some countries succeed in avoiding it, ultimately exceeding the precrisis trajectory. Although post-crisis output dynamics are hard to predict, the evidence suggests that economies that apply macroeconomic stimulus in the short run after the crisis tend to have smaller output losses over the medium run.
The research once more substantiates the notion that money is the key to recovery. During a recession, a nation is starved for money. A current account surplus brings money to the nation.
When there is a current account deficit, as always exists with the United States, money leaves the country. So a reliable, controllable source of money must be found. While many sources exist, the most reliable and controllable is federal deficit spending.
All six U.S. depressions resulted from federal surpluses; all nine recessions since 1959 resulted from decreases in debt growth and every recovery resulted from increases in federal debt growth (See: http://rodgermmitchell.wordpress.com/2009/09/07/introduction/).
There is no mystery to this. Money both prevents and cures recessions. Those who wish to cut federal deficit spending repeat the mistakes that lengthened the Great Depression.
Rodger Malcolm Mitchell