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It’s Too Soon to Celebrate a Recovery

Author: Peter R. Orszag
January 30, 2013


As the economy begins to show signs of strength, people naturally want to know, how long will the damage from the financial crisis linger? A new paper from the Bank of England suggests it may be much longer than we would like.

If that's right, then official economic projections remain too optimistic, even though they are more subdued than they were before the crisis.

The Bank of England analysis, by Nicholas Oulton and Maria Sebastia-Barriel, examines the well-known Reinhart-Rogoff episodes of financial crisis globally (named for the economists Carmen Reinhart and Kenneth Rogoff). The BOE analysis finds that crises reduce short-run productivity growth by 0.6 to 0.7 percentage point per year, on average -- a sizeable effect. Over the past five years, U.S. annual productivity growth has averaged only about 1.5 percent, so a drop of 0.6 to 0.7 percentage point is relatively big.

Perhaps more disturbingly, Oulton and Sebastia-Barriel find a significant long-run effect: For each year of a financial crisis, the level of gross domestic product per capita is reduced in the long term by 1.5 percentage points. In other words, a crisis lasting five years permanently lowers GDP per capita by a whopping 7.5 percentage points.

The authors include the appropriate caveats about their analysis, including that such estimates are based on averages and that each episode is unique. Nonetheless, they conclude that "banking crises as defined by Reinhart and Rogoff have on average a substantial and statistically significant effect on both the short-run growth rate and the long-run level of labour productivity."

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