By Steven K. Beckner
(MNI) – Because excess credit growth played a key role in causing
the financial crisis and deepening the recession, policymakers and their
advisors must take account of the aftereffects of the bursted credit
bubble in making economic forecasts, according to research by a San
Francisco Federal Reserve Bank economist released Monday.
If the extraordinarily negative impact of the credit-induced
financial crisis on employment and investment is not taken into account,
forecasters run the risk of “overstating” future economic growth and
inflation, warns San Francisco Fed research advisor Oscar Jorda.
Jorda contends that GDP forecasts should be lowered by 0.6 to 0.8
percentage points this year and 0.5 to 0.7 percentage points next year.
Inflation forecasts should be revised down by two-thirds to a full
percentage point, he says.
Jorda, writing in the San Francisco Fed’s latest Economic Letter,
does not address the issue of whether the Fed’s low interest rate policy
early in the last decade led to the expansion of credit that fuelled the
housing boom that preceded the crisis.
But he writes, “a cursory review of the 2008 global financial
crisis lends support to the notion that excess credit was the culprit.
Countries that experienced the largest credit booms, such as the United
Kingdom, Spain, the Baltic States, Ireland, and the United States, are
experiencing the slowest recoveries.”
Jorda adds that “excess credit” leads to “periods of
higher-than-average economic performance” — but at a price. The greater
the pace of credit expansion, he finds, the more severe the subsequent
financial crisis and ensuing recession.
Similar findings have been made by Carmen Reinhart and Ken Rogoff
and have been cited as a rationale for providing greater and more
extended monetary and fiscal stimulus.
“More leverage results in deeper recessions and slower
recoveries,” writes Jorda. “Moreover, in financial crises, leverage is
associated with a steeper and more persistent decline in consumption as
households try to repair their balance sheets. Since consumption
constitutes more than two-thirds of GDP, it is not surprising that
losses in output follow a similar pattern.”
“Weakness in incomes and the process of deleveraging put downward
pressure on prices, even in an environment of lower-than-normal interest
rates that lasts several years,” he continues. “Looser monetary
conditions take a long time to gain traction. During the first year of
the recession, private real lending declines by a similar amount
regardless of whether the genesis of recession is financial or
nonfinancial.”
Jorda says “it takes on average about five years before lending
approaches its pre-recession levels in recessions associated with
financial crises, while lending usually recovers more quickly in
nonfinancial recessions.”
As firms and households deleverage, the economy suffers.
“In the current environment of lower-than-normal interest rates, it
is perhaps investment, measured as a percentage of GDP, that has
suffered the steepest and most persistent declines,” Jorda writes.
“Investment is the variable that fluctuates most over the course of the
business cycle.”
“Normally, investment recovers within two years of the start of the
recession,” he goes on. “However, it takes substantially longer, often
several more years, for investment to recover in a financial recession.
That has serious consequences. A slower pace of capital accumulation
usually is detrimental to the long-run productive capacity of
economies.”
Jorda cites figures showing ” how much more severe and prolonged
the falls in employment and investment have been in the most recent
recession and recovery, eclipsing anything else observed in the United
States during the post-World War II period.”
He says “the financial crisis that followed the fall of Lehman
Brothers appears to have extended the recession by an extra year and
sunk the economy to extraordinary depths. Today employment is about 10%
and investment 30% below where they were on average at similar points
after other postwar recessions.”
Based on an analysis of the experience of 14 nations, Jorda
contends that the amount of leverage built up in 2001-07 leads to a
comparable amount of contraction. His analysis shows that “even years
after the recession ended, economic performance should be subdued, as we
are now experiencing.”
The lesson to be drawn, according to Jorda, is that “economic
forecasts should take into account the effects of the recent financial
crisis.”
“Compared with the average U.S. post-World War II recession, the
forecast for real GDP should be lowered 0.6-0.8 percentage point in
2012, 0.5-0.7 percentage point in 2013, finally returning almost to
normal by 2014,” he estimates.
“Similarly, inflation forecasts should be revised down between
two-thirds and a full percentage point over the next three years,” he
adds.
Jorda warns that “any forecast that assumes the recovery from the
Great Recession will resemble previous post-World War II recoveries runs
the risk of overstating future economic growth, lending activity,
interest rates, investment, and inflation.”
“The data suggest that, this time around, credit cannot be
considered a secondary effect,” he adds.
** MNI **
[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]