Looking past aftershocks
Recessions come in all shapes and sizes, but the downturn since the financial crisis of 2008-09 has been particularly long and nasty.
This should not come as a surprise. History shows that recessions following financial crises tend to be both deep and durable. In ‘normal’ downturns, economies rebound rapidly. Lost ground is regained and growth returns to trend in a year or so. But after a financial crisis, the situation is different.
Studies have shown that economies take an average of four and a half years just to return to their pre-crisis levels of income per head following a severe financial shock. Unemployment takes a similar length of time to reach its peak and housing market declines can last even longer. In addition, the real value of government debt tends to explode, rising by an average of 86 per cent in the major post-war crisis episodes.
Why is this so? One study of economic ‘lost decades’ – including downturns worldwide in the 1930s and Japan in 1990s – shows that these crashes were preceded by a 10-year run of economic prosperity, fuelled by a lengthy expansion of credit and increasing leverage. The inevitable period of retrenchment and deleveraging that follows destroys confidence and weighs heavily on spending and investment.
As seen in the past few years, it also reduces the effectiveness of monetary policy, since lower interest rates may stimulate little new lending. As a result, activity remains weak and employment lacklustre.
The current crisis is compounded by its global reach: looking at 182 countries throughout the world, half recorded outright declines in real headline growth in 2009. This globally synchronous crisis is particularly challenging because countries have fewer opportunities to offset weak demand at home, with growth driven by exports abroad.
It may be little wonder that Bank of England governor Mervyn King thinks we are only halfway through the travails that began five years ago. However, two recent developments could help lift the prevailing gloom.
First, oil prices have fallen by a sizeable 30 per cent in the past four months, underpinned by a pick up in supply. Opec’s (Organization of the Petroleum Exporting Countries) crude oil production levels are close to four-year highs. A simple extrapolation of current output levels through to the end of the year points to an overhang of oil stock in the major economies – reducing their need to buy more oil. As for non-Opec production, rising North American output is expected to more than offset record-low North Sea production and outages elsewhere. Concerns over the impact of sanctions on Iran also appear to have dissipated, at least for now, as supplies from Iraq and Saudi Arabia take up the slack. In fact, according to the International Energy Agency, the oil market is better supplied now than at the start of the year.