The Crisis: Monetary policy, “not guilty”. The fault lies with “human nature”

Rogoff & Reinhart insist with their argument that the economy is performing as best as is possible following a financial crisis.

This is the last question and answer from the interview:

What are some of the key lessons from the financial crisis and the recovery?

Reinhart: The U.S. recovery very much fits the mold of those following any severe financial crisis. The U.S. did not have as sharp an initial decline in output as what you have seen in emerging markets or, in effect, as what you saw in prior crises in U.S. history.—not just the Great Depression, but in the crises of 1907 and 1893, as well. In all of these, there were years where you had massive initial declines in GDP [gross domestic product] of 10% or 12%. In the Depression, it was 30%. We did not have that this time. But all the other developments were the same, including the failure to regain what was lost in income and employment, and how long it has lasted.

Post-war recessions, on average, barely last a year. And here we are having these conversations five years after the onset of the subprime crisis. It attests to the long duration of this type of systemic crisis. In the historical context, the U.S. has had, overall, a pretty good track record in the latest crisis. In terms of income per person and in comparison with other countries that are having similarly severe crises, we are doing pretty well–but not so hot in terms of unemployment.

Rogoff: We have always argued that the right metric for thinking about deep financial crises is to compare the current conditions to where you started. It is a much more robust method, particularly because there are false starts, and you don’t know when the recovery starts. It is really getting into semantics to say, “Well, we are not racing ahead that fast.” But the flip side of that is that a lot of effort was made to have the economy not fall that fast. There is basically fiscal stimulus being taken out of the economy, for example, as we are consolidating from the initial $800 billion stimulus in 2009. And if we hadn’t done that, there would be more room to make the economy grow faster now. But that doesn’t mean we would be ahead.

“We did not have that this time”. I certainly agree and would be surprised if more than one century later we would make the same mistake. But we did, only in much less intensity. Nominal spending in 2009 didn´t drop 13.5% like in 1894 (relative to 1892) but only 3% (relative to 2008). This was a first since 1938. But in 2010 we could have been much more “aggressive” in getting spending up, as it was done in 1895.

And isn´t it comforting to read Rogoff saying: “But the flip side of that is that a lot of effort was made to have the economy not fall that fast”. Yes, belatedly the monetary “breaks” were applied cushioning the fall, but what is lacking is the requisite monetary “acceleration” to get the economy back out of the “ravine”.

The Charts below provide the illustration.


4 thoughts on “The Crisis: Monetary policy, “not guilty”. The fault lies with “human nature”

  1. Apply leeches to a patient with anemia, and then say that such patents always take a long time to recover. Look very sober, speak with authority.

    That actually used to work—and still does when central bankers describe economies.

  2. I am somewhat on the fence with R&R as I see some merit to what they are saying; at least from the perspective of damaged financial markets and the psychology that comes with it. But the problem with their analysis is that it conflates an erroneous notion of causation with lack of remedy into one idea and expands upon that one idea, allowing cover for the central bankers to just come out and lie their rears off and skirt blame as Bernanke did in his speech to the Economic Club of New York. I don’t mind giving Bernanke an opportunity to save face and I think I’ve done that for the last few months; but that speech was really, really bad behavior – and I now wish I have never even heard of R&R.

  3. “But in 2010 we could have been much more “aggressive” in getting spending up, as it was done in 1895.”

    By this, I understand you to say that the faster recovery in 1895 than our recent experience was due to active policy measures undertaken in 1895 – if this is the case, could you explain what those measures were.

  4. Pingback: The Crisis: Monetary policy, “not guilty”. The fault lies with “human nature” | Brucetheeconomist's Blog

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