The US economy is once again flirting with recession. While most data still suggest continued growth, recent events have clearly turned in a more negative direction. Coming weeks will show whether the damage is bad enough to tip the economy into a full-fledged downturn. In the mean time, this period of slower growth is taking its toll on households.
While the rising threat of recession may not have been predictable, the generally sub-par performance of the US economy comes as no surprise. Extended periods of underperformance typically follow the kind of “balance sheet” recession that we passed through in 2008-2009. Economists Carmen Reinhart and Kenneth Rogoff have traced through 200 years of financial booms and busts around the globe, and they find that recoveries following banking crisis tend to be long and painful. Housing prices remain weak, high unemployment persists, and public debts rise substantially. The IMF has found that on average it takes about six quarters for output to return to its previous peak following a financial crisis recession, compared with about 3 quarters for the typical recovery. The current US recovery has been even weaker than that, since at eight quarters post trough we have yet to recover the level of output seen in the second quarter of 2008.
Why are recoveries following financial crises so anemic? Here, the answer is the nature of adjustments that are needed to repair excesses built up during the preceding boom. Researchers have found a fairly standard pattern of build up to a financial crisis that involves a credit boom (often following deregulation), which leads to rapid asset appreciation (including housing), which facilitates an unsustainable boom in consumption. Sound familiar? When the bubble inevitably bursts, the economy is left with severely damaged household and financial institution balances sheets, depressed asset and housing markets, and a heavy load of public debt.
The legacy of boom and bust makes for a very difficult recovery period. The need for households to “de-leverage” leads to an extended period of very weak consumer spending, and damage to banks reduces the supply of credit. Governments slash spending and raise taxes to address debt, further restraining aggregate demand. Workers from industries like construction are not rapidly deployed to other parts of the economy, so structural unemployment problems also persist. Recovery is a long, painful process.
A continuing sub-par US recovery has implications for Hawaii, as we have noted in past reports. Even if local residents avoided the worst of the boom excesses, tepid US consumer spending will holding back tourism, construction will not quickly spring back, the public sector will drag on growth, and difficult credit conditions will continue to bedevil many potential borrowers. Hawaii’s recovery, like that of the US, will continue to take time to be fully realized.
Carmen Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press, 2009.
International Monetary Fund, “From Recession To Recovery: How Soon And How Strong?” Chapter 3 in World Economic Outlook: Crisis and Recovery, April 2009, 97-132.