Diminished expectations, double dips, and external shocks: The decade after the fall

Is the global economic recovery about to grind to a halt? This column provides evidence on economic performance in the decade after a macroeconomic crisis. It finds that growth is much slower and as well as several episodes of “double dips”. It adds that many of these economies experience plain “bad luck” that strikes at a time when the economy remains highly vulnerable.

"The process of contraction, like the process of expansion, is cumulative and self-reinforcing. Once started, no matter how, there is a tendency for it to go on, even if the force by which it was provoked has in the meantime ceased to operate."--Gottfried Haberler, Prosperity and Depression, 1937

In our recent paper (Reinhart and Reinhart 2010), we examine the behaviour of real GDP (levels and growth rates), unemployment, inflation, bank credit, and real estate prices in a twenty-one-year window surrounding selected adverse global and country-specific shocks or events. This note summarises some of our main findings.

Chief among these is that economic growth is notably slower in the decade following a macroeconomic disruption. We extend our results to provide evidence of several post-crisis “double dips” in the years following a crisis. Indeed, a faltering of economic recovery is not uncommon after a severe financial shock – although this can often be ascribed to exogenous events.

We study the 1929 stock market crash, the 1973 oil shock, the 2007 US subprime collapse, as well as fifteen severe post-World War II financial crises. We have chosen not to look at the immediate antecedents and aftermath of these events and instead focus on longer horizons that compare decades rather than years.

Methodology preamble

Our statistical analysis, which is described in more detail in the paper, is based on nonparametric comparisons of the data that are applied to the episodes listed in Table 1. Simply put, we examine if key macroeconomic indicators seem to come from the same distribution before and after a dislocating event. The exact time periods of the before-and-after windows vary across our exercises, but we usually try to employ the longest possible spans of comparison.

Growth, GDP levels, and unemployment

Real per capita GDP growth rates are significantly lower during the decade following severe financial crises and the synchronous world-wide shocks. The median post-financial crisis GDP growth decline in advanced economies, as shown in Figure 1, is about 1%.