The misguided belief that “this time is different” ledpolicymakers to permit the credit boom of the early 2000’s to continue for too long, thus preparing theground for the biggest financial crisis in livingmemory. But now, when it comes to recovery, the belief that this time should notbe different might be equally dangerous.
Many policymakers and economists have observed that therecovery from the 2007-2008 financial crisis has been much slower than mostrecoveries of the post-war era, which needed only a little more than a year, onaverage, to restore output and employment to their previous levels. By thisstandard, the current recovery is unacceptably slow, with both output andemployment still below the previous peak. Policymakers thus feel justified inusing all available macroeconomic levers toachieve a recovery that resembles those of the past.
In doing so, officials are reluctant to take into accountthat the recent crisis resulted from an unprecedented credit boom gone bust. Tosome extent, it should have been logical to expect an unprecedented upturn as well. When the crisis erupted, manyhoped for a V-shaped recovery, notwithstandinga substantial body of research showing that recoveries from recessions causedby a financial crisis tend to be weaker and slower than recoveries from“normal” recessions.
The observation that recoveries following a financialcrisis are different suggests that standard macroeconomic policies might notwork as one would usually expect. And a transatlanticcomparison suggests that this may indeed be the case.
One would expect that the shock from the financial crisisshould be comparable for the United Statesand the eurozone, given that they are of similar size, exhibit a similar degreeof internal diversity, and experienced a similar increase in house prices (onaverage) in the years preceding the bust.Moreover, the relative increase in debt (leverage) in the financial system wassimilar on both sides of the Atlantic.
And, indeed, USeconomic performance has been very similar to that of the eurozone sincethe start of the crisis: GDP per capita today is still about 2% belowthe 2007 level on both sides of the Atlantic.The unemployment rate in the USand the eurozone has increased by about the same amount as well – threepercentage points.
Of course, one can point to particular countries in Europe that are miredin recession. But the USalso has depressed areas. For Irelandand Spain, read Nevadaand California (and, for Greece, read Puerto Rico). The proper comparison is thus between theaverage of two continental-sized economies, both of which are characterized byconsiderable internal diversity.
These similarities in economic performance are striking,given that macroeconomic policy in the US and the eurozone has been sodifferent. The USlet its fiscal deficit rise above 10% of GDP, compared to less than 6% of GDPin the eurozone. Measured over a five-year period (2007-2012), the US hasthus not done any better than the eurozone, although it has relied on a muchlarger dose of fiscal expansion. In the US(and the United Kingdom), the general government deficit today is still around8% of GDP, compared to a little more than 3% of GDP in the eurozone, and the USdebt/GDP ratio has increased by more than 41percentage points, compared to “only” 25 points in the eurozone.
In fact, the economy that has imbibedthe strongest dose of expansionary policyhas recovered less: GDP per capita in the UK today is still 6% below the 2007level. Of course, one could argue that the UK was particularly exposed to thebust, because financial services make up a large part of its GDP. But the factremains that its economy, supposedly the most flexible in Europe,has not recovered from the shock five years later, despite massive fiscal andmonetary stimulus, coupled with a substantial devaluation.
On balance, it thus seems that this time – or, rather, thispost-crisis environment – really is different, and that macroeconomicpolicies have done little to improve matters. Countries like the US and the UK, which are accumulating debt ata record pace, are betting that deficitspending will eventually pay off in astronger economy. But they risk ending up with debt/GDP ratios north of 100%, which would leave them at the mercy of financial markets should sentiment turn against them.
History suggests that interest rates will not remain atrecord-low levels indefinitely, and that when change comes, it might be abrupt. Why should we expect this time to bedifferent?