"Can output recover before credit does?
- Posted by:
- The Economist l LONDON
- Financial markets
GIVEN that the current global recession had its origins in a global credit crunch, it is not surprising that there has been much discussion of whether fixing the financial system (particularly, getting banks lending again) is a necessary condition for a broader economic recovery. Some, like Japanese economist Keiichiro Kobayashi, have argued that the answer is an emphatic yes, pointing to Japan's experience in the 1990s. Paul Krugman didn’t agree with Mr Kobayashi’s interpretation of the Japanese experience (but Mr Kobayashi argued in response that Krugman was using the wrong period in Japanese history to make his point).
Now a group of IMF economists have thrown their hat into the ring, so to speak. They looked at the timing of recovery of credit and output in recessions that are associated with credit crunches (they identify 21 such episodes in OECD countries between 1960 and 2007). Their research suggests that recoveries in aggregate output and its components following such recessions "tend to take place before revival or credit growth". They find similar patterns for recessions related with house-price busts. Here, too, real output begins to recover first: in their data, on average nine quarters before house prices bottom out.
This might sound like good news given the difficulty of satisfactorily cleaning up the mess in the financial system this time, but it isn't quite. For one thing, as the IMF has previously pointed out, any recovery from a recession that originates in a financial-sector collapse tends to be slower and shallower than one that does not have such roots. The second worry that the research points to is that household consumption is the part of aggregate demand that recovers first (investment lags). But how quickly consumption picks up depends on the pace of adjustment in households' balance sheets. That's not a finding that augurs well for this recession, where household balance sheets are in for a painful adjustment.
So, output can recover even if credit availability is limited. But perhaps Mr Kobayashi’s interpretation of Japan's 1990s experience is the relevant one this time around. At any rate, next time recessions and recoveries are compared, there'll be one extra data point (although there are still likely to be violent disagreements among economists over which side of the story it backs up). "
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